When trading, as in any activity involving risk, you must have a clear and coherent Money Management plan. Without it you would try to build a house without laying the foundation first. Many traders miss this important aspect of trading, as there is more to it than just counting your money. Then, just as important as drawing a plan to stick to it, Discipline is the golden rule here.
Developing a coherent plan begins by asking yourself the following 3 questions;

  • How much do I want to risk?
  • How much do I want to risk per day?
  • How much can I risk per trade?

 

 

Risk management trading system

Answering the first question can be quite easy, for example, I have £5000 and I want to put my trading skills to the test so that is an amount I can risk. However, out of the £5000 you start out with, you can limit your maximum loss to £2,500, which is reasonable. If your trade only results in losses and you find yourself losing 50% of your capital, it’s probably best to stop. Take a step back and try to figure out what’s going on. It seems obvious at this point that there is something wrong with your trading plan and it needs reconsideration.

The second question is a bit more complicated and a bit more thought out. How often do you think about trading ? Given the example above, how quickly are you willing to risk breaking past £2500 before you have to stop? My feeling is that you shouldn’t risk burning your capital in less than 2 to 4 weeks, that means 10 to 20 trading days. So you should think in lines from 1/10 to 1/20 of your capital each day. This means you will be risking between £250 and £125 per day.

Are you an ‘active’ trader?

This assumes that you will trade actively or trade at least once a day. What if you only intend to trade occasionally? Perhaps on the back of an idea you’ve had, or a recent news stream. Let’s say you can trade every 2 or 3 days. In this case, it would be tempting to think that you can total the amount you are not risking on days when you are not trading. So  I haven’t traded for 2 days, I could risk £750 or £375 today on one trade . This in effect only increases the risk you are taking and you could find yourself down £2250 with just three bad trades. Yes, it can still take you two weeks to accumulate this loss, but you only lost 3 wrong trades and that can happen very easily. So again in this case it’s best to stay at 1/10 or 1/20 per  transaction day or something close to 1/20 if all in one trade.

This leads us to answer the final question, what is the acceptable level of risk per trade? This depends on how many times you want to trade a day and if you are willing to spend a lot of time in front of your screen. It is also possible that you only have enough time to make 1 trade per day, in which case I recommend single trades (and daily risk), at most  1/20  of your risk capital. you, in the case of over £125.

Let’s say you have decided to risk £200 per day trading binary options and you have a plan to trade every day. You can put it all in one trade and see if you succeeded. This will ultimately be the most dangerous route. It depends on how much time you can spend on trading but I would divide any daily number you have decided on between 2 and 4 trades. You don’t have to create them all, but it’s better to give yourself a few opportunities a day, not just one. If you have time, it can be more beneficial to scale the daily risk in different trades.

 

 

Brokers with low minimum trade sizes

 

Apply money management with binary

What I like most about trading Binary Options is that the risks are well controlled. You know what your maximum risk per trade is when you place it and it is simply the cost of the option. However, human emotions can show up, especially on a bad day. As we have seen above if you lose your daily risk amount then you should basically turn off the screen and wait for tomorrow.

This is probably the most difficult task to follow. As a trader you will feel you can get it right, just one more try is all you need. But we should look at it this way, let’s say you have a daily risk limit of £210, which you split into 3 trades of £70 each. If you happen to get all three wrong, you can’t get the fourth right either, simply because of fatigue or trading based on emotion .

By this point you may be upset or not in emotional balance, which can lead to poor judgment and is more likely to cause you to choose another losing trade. From a money point of view, you dropping £210 and placing another trade will give you the best chance of making 90% or £63 back, which won’t give you a profit of the day, but losing that trade will gives you an extra £70 off to a total loss of £280 for the whole day.

That can only feel worse, and more dangerously can start a very risky spiral where you no longer have a limit on how much you can lose a day or total. Limits are a good way to encourage discipline  in trading.

You can also add multiple rules or limits. Take the example above (£210 daily limit divided into 3 trades), you can add rules; 2 losses in a row and I was gone the same day. For example, let’s say you start your day with 3 wins in a row, there’s no reason to stop on the winning streak. But now let’s say you lose the next two.

Now you still have profit for the day, and can walk away. This rule, consisting of 2 losses and runs out, will protect your profits for the day and limit the loss of not only your gain but also your daily risk limit. If you keep trading you can make two more winning trades but you can make two more losing trades, in which case it’s up £210 for the day you find yourself down £70 for the day.  2 person direct loss trades = outbound rules can help protect your winnings. Remember in trading one of the most important concepts is preserving capital and being able to trade again tomorrow.

Rules like these may work for some investors and not others – but three basic questions remain. One thing that every broker can agree on, is that money management is paramount when it comes to trading success.

Percent rule

Another popular strategy for money management is to never risk only a certain percentage of the total investment fund. One of the benefits of this system is that the trade size increases after a series of winning trades, and likewise shrinks in the event of a loss.

The percentage rule represents a very simple system. With any single trade, only a certain percentage of the fund is at risk. This will rarely be more than 5%. A sustainable, low-risk strategy can commit as little as 1% of the total amount.

The rule isn’t as strict as much as the percentage doesn’t need to be pre-calculated for each transaction – just regularly use the underlying basis. So someone with a £1000 trading fund, might decide to open a trade at £20 per trade – 2% of the fund at risk per trade. That £20 trade size could stay in place until the fund hits £1200 (or it could suffer some setbacks and hit £900). At this point, the trade size can be adjusted.

So the calculation is not done but just a measure for the next trading period. Some traders may rebase once a month, others at the end of each trading day. The mechanics are not the key to the system – the point is to risk only a small percentage of the total balance on each transaction.

Computer table

To assist with using the percent-ruled trade sizing system, below is a quick table to show trade sizes ‘at a glance’, with different fund amounts and percentages. Those who want less risk per trade will want to use a smaller ratio, and those who take a higher risk will use a larger ratio. Fund size can be multiplied accordingly, as well as percentage.

 

1% 2% 5%
Total balance   
£ 100 £ 1  £ 2 £ 5
£ 250 £ 2,5   £ 5 12,5 pounds
£ 500 £ 5 £ 10   £ 25
£ 1000 £ 10 £ 20 £ 50

 

 

The calculator above shows how important it is to check the minimum trade size at any potential broker if the fund is on the low side. Traders can easily find themselves risking more per trade than they want to because the minimum trade forces them to risk a greater percentage of their total bankroll.