Money and Risk Management

A Guide to Understanding Money and Risk Management

I guarantee that the most successful online traders are those that have adopted an effective trading strategy; beginning with some careful money management calculations, and supported by proper risk management techniques.

Excellent money management is essential for trading in both the forex and binary options markets. It is imperative that your trading account can adapt, according to the challenges posed by volatile financial markets. Therefore, managing your trading account is as much about understanding these markets, calibrating the size of your trades and expectations, as it is about patience (with patience being the key to avoiding overtrading).

You must remember, that even if the analysis of a market is correct and all actions follow suit, an account can still suffer losses. In binary trading this can happen by simply choosing the wrong expiration date to accompany a good striking price. In forex trading, not knowing when to bow out may result in doubling a position (or more), leading to a loss in finances.

The best money management strategy that I can ever recommend is to only ever risk a portion of your account on any one trade, with clear rules not to have more than a specific number of positions simultaneously. Avoiding correlated trades in each batch will also benefit you.

For instance, if trading long on the USDCAD pair, it is not wise to trade short on the AUDCAD pair, as they are inversely correlated. In other words both positions would be the equivalent to two longs on the USDCAD, and if incorrectly placed, the loss will be double. Fundamentally, this is overtrading.

Another financial management technique for forex trading is to consider investment margins. 30% of an account is considered the maximum margin to be invested at any one time. This strategy will ensure that if the market turns sour, the account is only minimally exposed and should be able to recover. A healthy balance of both technical and fundamental analysis (as a basis for placing a forex trade), along with disciplined money management techniques should also be considered.

Yet, for both forex and binary options, even with intelligent analysis and a well-played strategy, money can still be lost. Essentially, a trader must be able to acknowledge any personal shortcomings, as well as their strengths and capabilities. Above all else, greed and fear will always push an account into overexposure.

As they are the safety nets for moments of personal weakness, I suggest devoting considerable time to well planned money management strategies.

Techniques for Forex Risk Management

No trading strategy is capable of offering a 100% protection against losses, which is why risk management enables a trader to stay solvent even when investments turn sour.

The most popular risk management technique follows similarly to that which I have already mentioned – to invest only a small portion. This time I’m speaking of individual trades, not of your overall account balance. In this case, it is advisable to risk usually just 1% to 3% when opening a position. This way your account is not depleted, and if you indeed lose your account using this rule, it means you over traded, or perhaps you are simply ill-prepared to live trading the FX markets – implying that either your technical or fundamental interpretation of markets is flawed.

Trading with a stop loss at all times and avoiding movement is key to respecting your initial plan and general risk management. A stop loss has the advantage of freeing up margin in your trading account, which can then be used to help you climb out of a bad trade.

Proper risk management techniques should not only allow survival in this ever-challenging environment, but should encourage balanced growth. Risk-reward ratios can have this effect on your trading account, but the ratio should also be adapted to the currency pair you are trading.

However, it isn’t desirable to use the same risk-reward ratio on all currency pairs. Each market has its own particularities, in the sense that some currency pairs are moving faster than others, and therefore the distances travelled are different. An appropriate risk-reward ratio is considered to be anywhere between 1:1.5 and 1:2.5, with anything below or above this range to be avoided.

Finally, using correlations should also help you to diversify and even hedge your portfolio in difficult times. Majors and crosses move in correlated ways, as well as risk-off/risk-on markets.

Techniques for Binary Options Risk Management

When it comes to binary options trading, different risk management techniques and strategies must be applied.
Unlike the fx markets, binary trades lock your option to the predetermined expiration date. This means that if things go wrong after the option is traded, it’s down to human nature and confidence in the analysis made.

However, binary brokers offer several possibilities for coping with a trade that goes against you, and one of the most popular one is early closure. This trade tool offers the chance to exit a trade before the expiration date is reached, affecting the total reach of any losses. For example, if the market goes against you and your option is sitting out of the money at a specific moment of time before the expiration date, the broker may allow you go out of your trade for a fee that is less than the cost of your option when it expires out of the money.

The same feature is valid for options in finishing in the money too. Exit at any time with a small gain, rather than stay in and risk to gain more if the option expires profitably. This possibility should be incorporated into any risk management strategy as it allows the trader to use the newly acquired, ‘free’ margin, to invest in another trade that may have bigger chances to expire successfully. This might not seem appealing, but that really depends on your risk appetite.

Range trading is an essential risk management tool that is best used when markets aren’t travelling much, or when they are expected to be in a range. One touch options and boundary options with short-term expiration dates, and high-low options with bigger expiration dates, should be traded in these periods. This will help to diversify the portfolio, plus it will help you to avoid the reason why the ranges are small (e.g. ranges in the Asian session, ranges before important economic releases, etc.)