Every trader knows how important risk management is. It is hands down the most important concept to master for a trader of any skill level. Traders generally know what their personal risk tolerances are but for some it can be difficult to manage this risk in a larger portfolio with many positions. This becomes even more difficult when a trader has a large amount of exposure to derivatives in their book. Options values are more dynamic than stocks. There are many different factors that affect the value of an options contract so it can be difficult for a trader to truly understand what their risk is at any given time. With the use of binary options and a solid confidence scale a trader can greatly reduce this uncertainty.
A confidence scale is something that a trader develops to suit their own risk tolerances. A trader would rank a trade before they enter a position and then size that position according to how confident they are in the trade. By thinking about risk this way a trader will never find themselves in a trade that blows out their account.
A trader’s confidence scale could look like this:
Confidence 1 – A traders most confident positions, these are the trades that the most risk is allocated to. That does not mean that a trader can risk as much as they want in these trades. For example a trader could choose to risk between seven and ten percent of their total book in these trades. This allows protects a trader from a single position blowing out their book. For day trading a trader’s max risk should be less than for swing trades.
Confidence 2 – These trades are a trader’s second most confident positions. They may choose to risk between five and seven percent of their book in these trades and again sizing positions along these lines protects a trader form blowing out their account.
Confidence 3 – A trader may choose to risk between three and five percent of their book in these trades.
Confidence 4 – A trader may choose to risk between one and three percent of their book in these trades
Confidence 5 – A trader may choose to less than one percent of their book in these trades.
While the values above might not make sense for every trader all traders should be thinking about risk across their book in this manner. They should come up with risk levels that they are comfortable with and then stick to them. It can be difficult to determine max risk in some standard options positions but due to the settlement nature of binary options a trader can easily follow this guide when trading binaries.
No matter what product a trader is trading it is crucial to think about risk this way. Binary option trading makes these considerations a little bit easier and due to the low notational value of binaries any trader can use them to structure their risk this way. Remember risk management is the most important part of any trading plan.