What is Money Management?
Money management is the process of managing the cash usage of an individual or organization. This process includes spending, saving and investing money. In this article, we use this phrase in connection with financial markets, specifically binary options trading and examine how a binary options trader shall make investment decisions.
This process is one of the most important aspects of binary options trading. When you trade binary options, you either win or lose the money you invested in that particular position. If you purchase a call option, it is possible that the price will decrease, so you put your money at risk. Therefore, you should try to protect your account balance.
One of the benefits of binary options trading is that both the potential gains and the losses are pre-determined, so the risk is limited. The most you can lose is the amount risked on that trade. This is why binary trading is getting more and more popular among traders. However, it is still necessary to use money management for the case of a losing trade. The way of managing your capital determines the risk of your trading.
How Can an Investor Exercise Money Management in Binary Trading?
You may use various methods to set up an effective money management strategy for binary options trading. You definitely need to manage your investment capital in a way that minimizes the risk.
The simplest method is that you need to avoid staking all your capital on one investment, because the risk is too big. This refers not only options trading, you need to keep this in mind in case of any investment activity. This rule seems to be really simple, but it is astonishing that there are people who still invest all of their hard-earned savings in one opportunity and lose all their money.
Certainly, if you want to be a successful trader, you need to apply more advanced techniques to control the risk. First, you have to define the amount of money allocated to trading binary options. Then you need to specify the amount of money that you are willing to risk on a trade. As the amount of capital invested increases, the potential reward and risk grows. The investor’s task is to determine the optimal risk in order to achieve a specific return.
The most important here is to specify the trade size. Commonly used money management methods are the fixed bet, the fixed-fraction bet strategies as well as adjusting bet size to volatility
1. The fixed betting strategy keeps the trading size unchanged, even if the portfolio grows. So, you always place trades of 10 dollars regardless of the amount of your capital, no matter whether the size of the trade is proportionately too large or too small. For example, a 10 dollar bet seems reasonable on an account size of 500 dollars, but it would be too large on a 100-dollar account and might be too small on a 20,000-dollar portfolio.
2. This problem can be solved with using the fixed-fraction bet, which is a proportion of the capital. A 5% fixed-fraction of a 1,000-dollar account is a 50 bet. If your capital increases or decreases, the fixed-fraction bet stays in proportion to the equity. So, if the amount of your portfolio became 5,000 dollars, the fix-fraction bet would rise to 250 dollars. A 5% trade size is considered reasonable.
3. Another money management technique is to adjust the bet size based on the payout and volatility. Short term options require a smaller bet size as the payout is smaller and the volatility is greater. Also, you should avoid trading on days when there is high volatility, for example before an important economic data release.