Determining The Right Binary Options Position Size

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Determining Binary Options Position Size

You have what you believe is a great trade setting up, and you’re ready to take a position, but how much do you “bet?” Position size is something many traders don’t think about, they just take a position they think they can afford and hit the buy button. Unfortunately, determining position is a bit more complex than that, as your position size should account for the amount of capital you have and the risk you’re taking. Position sizing in trading falls under the category of money management, and should be lain out in explicit detail in your trading plan (see: In Beginners Trading Concepts: Creating a Trading Plan). Here is how to determine the exact position you size should be taking when trading binary options.

Why Position Size Matters

No matter how good your trading strategies, or how good of a trader you think you are, losing trades happen. Additionally, you don’t know on which trades you will lose. By always managing your position size, you minimize the chance of a handful of trades decimating your account.

The biggest problem for most beginner traders is taking a position that is too large for their account. Doing so puts the trader at a great risk of depleting the account so much that it becomes nearly impossible to earn it back. Other traders have more control at the beginning, betting small amounts that align with their account size, but then something changes. Once a few losses occur, they begin to “double up” or increase their position in order to make up for the losses. This is a dangerous strategy–if the string of losses continues the account may be completely wiped out.

A less common problem is not betting enough. If your trades are excessively small for the account size you have, then it is unlikely you will be able to meet your trading goals since you won’t make enough on each trade. In this case, risk is not the concern, but inability to grow capital is.

Taking the right position size is a balancing act between facing losses that are too large, and rewards that are not large enough. To get the proper balance, you must first establish your percentage-at-risk rule.

“Percentage-At-Risk” Rule

This rule determines the maximum percentage of your account you’ll risk on a single trade. To give you an idea, professional traders generally risk 1% of their account, or less, on each trade. This may seem small, but it makes sure that no single trade, or even a long string of losses, hurts the account substantially.

Risking 1% or less on a single trade can be a big challenge when trading a small account, but becomes much easier to adhere to once the account is larger. For example, if you open an account for $1000, the most you can risk $10 on each trade. If you have a $500,000 account, you can risk up to $5000 per trade, but if short-term trading you likely won’t even risk that much on each trade. Therefore, with a small account you’re at a disadvantage; but small accounts can slowly grow into bigger accounts by not taking on excessive risk. Avoid the urge to “gamble” by taking on trades that are too large for the account.

Professional traders didn’t come up with this rule after becoming professionals, they used the rule to become professionals.

If your account is too small to use the 1% rule, it is recommended you don’t trade till the account is adequately funded to trade properly. Alternatively you can increase your risk threshold, risking 2% or 3% of your account on a single trade; but this is not recommended.

Write down the maximum percentage of your account you’ll risk on a single trade, and write it in your trading plan.

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Calculating Position Size

Now that you have your percentage-at-risk rule in place, you can determine your position size. Your position size will fluctuate based your account size and the riskiness of the trade. Therefore, not every trade will be the same size. Let’s look at a couple examples for determining position size with binary options.

When you make a binary options trade, you know your risk. The only thing you need to know is the maximum percentage of your account you’ll risk. If you’ve chosen to risk up to 1% of your account, and you have a $5000 account, you can buy a call/put for up to $50.

Some binary options brokers will give you back a 0% to 10% credit on your investment when you make a losing trade. The amount of the credit is provided when you make a trade, allowing you to further fine-tune your position size.

If you know you will get 10% of your investment back if you lose, you’re not actually risking the full amount you invest. You can therefore take a slightly larger position. In this case, you can make a $55 trade, knowing you’re only actually risking $49.50 [$55 – ($55 x 10%) =$ 49.50]. Your total risk is still less than 1% of the account, but you have maximised the position size.

If the amount of capital in your account declines, this will reduce your position size. If the account grows, you will be able to take larger positions.

Final Word

Money management is arguably the most important aspect of trading, and one of the biggest factors in managing your money is position sizing. Try to risk less than 1% of account on a trade; read books by, or interviews with, professional traders and this rule (or something similar) is a common theme. If you have a small account, choose a broker that allows you trade in small increments; you’ll be able to stick to your money management rules and trade positions sizes that align with your account size. By using proper position sizing you dramatically decrease the risk of rapidly depleting your account due to a string of losses. At the same time, if you are utilizing a high win ratio strategy, you’ll be able to slowly grow your account and hopefully meet your trading goals.

Determining binary options position size

Written by on March 12, 2020

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How Much to Risk on Each Binary Options Trade

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Binary options are an all-or-nothing option type where you risk a certain amount of capital, and you lose it or make a fixed return based on whether the price of the underlying asset is above or below (depending on which you pick) a specific price at a specific time. If you are right, you receive the prescribed payout. If you are wrong, the capital you wagered is lost.

That definition has expanded though. Back in 2009, the US-based Nadex exchange created options that allow traders to buy or sell an option at any time up until expiry. This creates a wide range of scenarios, as a trader can exit for less than the full loss or full profit.

No matter which binary options you trade—Nadex options or traditional binary options—”position size” is important. Your position size is how much you risk on a single trade. How much you risk shouldn’t be random, nor based on how convinced you are a specific trade will work out in your favor. View position size as a formula, and use it for every trade.

How much to risk on each binary options trade

How much you risk on a binary option trade should be a small percentage of your overall trading capital. How much you want to risk is up to you, but risking more 5% of your capital isn’t recommended. Professional traders typically risk 1% or less of their capital.

If you have a $1000 account, keep risk to $10 or $20 (1% or 2%) per binary options trade. Risk 5% ($50 in this case) is the absolute maximum and isn’t recommended. When you start trading you’ll want to make as much money as you can, as quickly as you can. Making some quick cash is why many people attempt trading. Avoid this impulse though. Risking a lot on each trade is more likely to empty your trading account than create a windfall. Most new traders don’t have a trading method they tested and practiced, and therefore have no idea if they are a good trader or not. Better to risk small amounts of capital on each binary options trade, to test your trading methods and hone your skill, and then gradually increase the amount you risk to 2% once consistent.

How to Determine Risk on a Binary Options Trade

Binary options have a maximum fixed risk. This lets you know in advance how much you could lose if the asset (called the “underlying,” which the binary option is based on) doesn’t do what you expect. For binary options, the risk is the amount you wager on each trade.

If wager $10 on a binary option trade, your maximum loss is $10. Some brokers offer a rebate on losing trades; 10% for example. If this is the case, your maximum is only $9, calculated as:

maximum loss + rebate = trade risk

-$10 + ($10 x 10%) = -$10 + $1 = -$9

Nadex binary options don’t have rebates on losing trades, but if you buy an option at 50, and it drops to 30, you can sell it for a partial loss, instead of waiting for it to drop to 0 (or move above 50, which would produce a profit). Ultimately though, at expiry, the Nadex option will be worth 100 or 0. Therefore, when determining your risk you must assume the worst case scenario.

Nadex binary options trade between 100 and 0. With each digit representing a $1 profit or loss. If you buy one option at 30 and it drops to 0, you have lost $30. If you sell one option at 50 and it goes to 100, you have lost $50. You can trade multiple contracts to increase the amount you make or lose. This is a tutorial on position size, not Nadex options.

Determining Position Size on a Binary Options Trade

You know how much you are will risking risk (percentage of account, converted to a dollar amount) and you know how much money you could lose in a binary options trade. Now, tie the two together to calculate the exact amount of money you can wager on a trade.

If you have a $3500 account, and you’re risking 2% per trade, the maximum you want to lose is $70. If the broker offers no rebate on losing trades (this is the norm), then only risk up to $70 on the trade.

In the “Amount” box on the binary options trading platform, input $70 (in this case). That means you are willing to risk $70 on the trade.

If the broker offers a rebate, for example, 10%, then you can increase your position size by the amount of the rebate. in this case 10%. Because of the rebate, you can risk $77 on a trade ($70 plus 10%). If you lose you will receive a $7 rebate, so your maximum loss is still only $70, which is in line with your 2% risk parameter.

For Nadex binary options you have an extra step because you can purchase an option at any price between 0 and 100, which affects how much you could lose. Assume you have a $5500 account and are willing to risk 2% per trade. That means you can lose up to $110 per trade and still be within your risk parameter. Don’t take a trade where you could lose more than $110.

Assume you want to trade a gold binary options contract, because you believe the price of gold will rise today. You can buy the option at 50. If you are right, and gold is higher than the strike price (price level of gold that determines if you are right or wrong) when the option expires, the option will be valued at 100. You make a $50 profit on each contract you buy. If gold is below the strike price when the option expires, its value is 0, and you lose $50 on each contract.

Therefore, your risk is $50 for each contract you trade. You are allowed to lose up to $110 per trade, so you can buy two contracts at $50. If you lose on the trade you will lose 2 x $50 = $100. This is below the $110 allowed. You can’t buy three contracts though because that exposes you to a $150 loss. A $150 loss is more than your established risk tolerance.

Considerations for Real World Trading

When you’re starting out, calculate your ideal position size for each trade. Even when actively day trading there is time before each trade to quickly determine how much to wager based on your percentage risk tolerance and the trade you are considering. This repetition will serve you well, and when you are losing money the dollar amount you can risk will drop (as the account value drops) and when you are winning the dollar amount you can risk will increase (as the account value increases). Note that your percentage at risk doesn’t change, but as your account value fluctuates the dollar amount that percentage represents does change.

As your account stabilizes you may trade the same amount on every trade, regardless of the fluctuations in your account. For example, the balance in my trading accounts stays the same. I withdraw profits at the end of each month, and any drops in the balance are usually quickly remedied by a few winning trades. Therefore, there isn’t the need to make tiny changes to my position size on every trade. If your account value stays around $5000 (because of profit withdrawals, or profits and losses balance each other out), and you risk 2% per trade, then risk $100 per trade. Don’t reduce or increase this amount by a few dollars every time your account fluctuates slightly above or below $5000.

The point of only risking 1% or 2% of the account is that you can lose 100 or 50 trades in a row before you are cleaned out. That’s a good level of safety. if you are using a researched, tested and practiced strategy.

Not constantly changing your position size for every minor fluctuation in account value also allows you to make quick trading decisions in fast moving market conditions. If you know you can risk $100 on a trade, you can just act, instead of calculating if you can actually risk $105 or only $95. In the long-run, it won’t matter too much.

Once you are creating a good income for yourself, and you are happy with your account size (withdrawing profits over that amount) then it is quite likely you will trade the same position all the time, and it will rarely change.

Final World on How Much to Risk on a Binary Options Trade

First, establish the percentage of your trading capital you are willing to risk on a single trade. Ideally, this should be 1% or 2%, with the absolute maximum being 5% (not recommended). For a normal binary options trade, this dollar amount gives you your maximum position size. For a Nadex option, also consider your maximum risk on the trade, and then calculate how many contracts you can take to stay within your risk limit.

In the beginning, calculate your position size on every trade. It’s a good skill to have. As your account balance stabilizes—as you improve as a trader—you may opt to use the same position size all the time, regardless of the minor fluctuations in account value from day to day.

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