Introduction to Risk Management The 5% Rule Risk Management Explained Binary Risk Management Strategies Binary Risk Management Tools

1. Chapter 4:
Risk Management
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2. As an investor in the markets, you want to
move from being the person who deposits
their money in the bank to avoid risk
management, to being the bank where you
manage risk by investing in different equities
and obtain a higher rate of return. The better
you are at risk management, the more risk you
can take, and the more profit you can make.
As in business, all forms of financial trading
involve a certain level of risk. This is where the
role of risk management comes into play.
Essentially risk management is all about
identifying strategies where you can augment
your net present value as an investor. In
additional, it is also about finding out where
precious limited resources can be allocated in
order to maximize your profit potential while
at the same time minimizing the chances of
losses.
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3. THE 5% RULE
As a general rule when it comes to financial trading, traders are recommended not to risk more than 5% of
their total investment capital for each trade that they made. For example, if you only have $1000 in your
trading account, then you should not risk more than $50 at any given time. The reason for this 5% rule is
simple.
RISK: THE 5% RULE TOTAL INVESTMENT CAPITAL
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4. In a volatile trading environment like the financial markets, nobody can win all the time. Even the
best traders sometimes suffer from a losing streak. By adopting the 5% rule, you can ensure that
your investment capital won’t be totally wiped out if your trades suddenly go south.
RISK MANAGEMENT STRATEGIES
With the popularity of online trading gaining ground among retail traders, you can probably find
plenty of risk management strategies on the internet. They come in all forms and shapes such as
hedging strategies or straddle strategies all geared towards helping the trader to find the ideal entry
and exit points with the minimum level of risk. While these strategies might work well if you are
trading with the actual underlying asset or vanilla options contract, they might not be entirely
suitable for binary options.
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5. BINARY RISK MANAGEMENT STRATEGIES
As mentioned in chapter 1, with binaries, you are just dealing with derivatives and not the actual underlying asset.
Furthermore, because of the way binaries are structured, the methods used for trading binaries differ significantly
fromtraditional forms of financial trading.
First of all, there is no margin trading involved. This means you can only lose what you invest and not more. Secondly,
since the outcome is based on a Yes/No proposition, the usual intricacies associated with options trading are
eliminated. You no longer have to worry by how much the market has to move before your trade ended up in the
money. Your main concern is just the direction of the price movements. Due to these reasons, risk management for
binary trading has to be handled differently.
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6. RISK MANAGEMENT TOOLS
GET QUOTE FEATURE
Because of the relatively low risks involved in trading binaries, most binary brokers offer very little in the way of
risk management tools. Thankfully as an anyoption trader, you have an array of tools at your disposal that you
can utilize for risk management. For example under the Option+ trading mode, you have access to “Get Quote”
feature which can be used to close a trade early.
Clicking on the “Get Ouote” button will reveal a popup screen which displays the price which you can if you
decided to close your trade there and then. Normally, the price that you will get is less than your original
invested amount. However, sometimes it is possible because of a price spike in the underlying asset, your
quoted price will end up higher than what you originally invested. The image below is an example of such a
scenario.
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7. TAKE PROFIT FEATURE
Another interesting feature about the anyoption™ trading platform which can be utilized for risk
management is the “Take Profit” feature. This feature sounds an alarm as soon as your trade moves to
“in the money” status. Once the alarm has sounded, you can either choose to close the trade
prematurely or let it run until it expires. Now instead of facing the prospect of losing all your possible
profits by the time your trade expires, you can use the “Take Profit” feature to lock in your profits to
avoid losing them altogether in the event the market turn south.
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8. ROLL FORWARD FEATURE
Another way with which you can manage your risk with the anyoption™ trading platform is by using the “Roll
Forward” feature. What this feature does essentially is to let you postpone the expiry time of your trades to the next
trading cycle for a small premium. So when do we use this feature?
For example, let’s say that the Federal Reserve chairman is going to make an announcement about the direction of
the US monetary policy for the near future.
You suspect that with the announcement the price of gold will rise in relation to the USD. So you decide to invest
$100 in a call option for gold, which offers you a return of 70%. Supposing the announcement is scheduled for 14.00
GMT, this implies that the market will only react to the announcement only after 14:00 GMT. As such, you decide to
enter the market at 13.45 GMT with an expiry time at 14.15 GMT hence giving the market time to react to the news.
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9. However halfway through the Federal Reserve chairman’s speech, you noted that he would not touch on the news
about the US monetary policy until after the expiry of your trade which is at 14.15 GMT. This mean you will end up
out of the money then. To avoid making a loss, you can roll over your trade to the next trading cycle to expire at
14.45 GMT for a small premium. By doing this, you not only avoided making a loss but still managed to turn a profit
(albeit a smaller one). Although in our example, the amount of profit is less than what you had hoped for initially, you
should take heart that you prevented a complete loss. This is the essence of risk management, minimizing your losses
or turning losers to winners.
In the world of finances, the risk of losing money is a reality no matter how
much we plan to avoid it. In fact nobody plan to lose money, but having said
that it doesn’t mean one shouldn’t have a plan for minimizing one’s loss
either.
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