Binary Options: Strategies for Directional and Volatility Trading

CHAPTER 14

Risk Management

The next big component of a trading system is determining how much to risk on each trade. This is probably the most important aspect of a trading system. The point is that you are always going to be right on some trades and wrong on others. The idea is to make the numbers work out in a way so that you will make more money on your winners than you will lose on your losers.

This, of course, is not an easy task. The first component is to determine trade size so that you don't have a single trade that will wipe out your entire account or, even worse, your life savings.

The first question that you have to ask yourself is: How much am I willing to risk on any one single trade? There is a risk management principle referred to as the 2 percent rule. And this is basically a rule of thumb stating that you should not exceed a loss of over 2 percent of your account balance on any one single trade.

For example, if you have a $10,000 account, you should not lose more than 2 percent of that account ($200) on any one single trade.

The 2 percent rule is a great rule of thumb to use; however, the numbers should vary a bit. They should be anywhere from 1 to 5 percent, depending on how many consecutive losing trades your entry and exit condition produced historically.

THE PROCESS

Here is how the process works:

The first thing you need to do is to check how many consecutive losing trades your system can have in a row and how much dollar/point profit you are going for on ...