Using a sound money management strategy is pivotal part of trading success. Forget the indicators or strategies that you use to find trading opportunities. If you don’t follow sound money management as a part of your overall strategy then you might as well give up now. Yes, it really is that important.
Binary Options by their nature tend to fuel poor money management. The high returns that brokers market often result in new traders trading without a proper plan. This is of course what brokers expect uneducated traders to. It helps to boost their profits.
Unfortunately the loaded win loss ratio on these contracts will soon see an account emptied if risk it not controlled. For this reason it is important to stick to a proper plan for money management when trading binary options.
Below I provide an overview of three popular money management strategies that are often suggested for use with binary options.
The Martingale money management strategy is one of the most well known systems. It is believed to owe its origins to an 19th British Gambler Henry Martingale.
This is a progressive money management strategy that assumes even odds. It works by doubling up the stake after each loss. This works successively, with the size of the wager doubling after each successive loss. It works on the basis that the eventual winning position, when it happens, will cover all previous losses.
While this system can work if your strategy can guarantee only a limited string of losses, the obvious problem is that in most cases, the capital limit in exceeded before the required progression can be completed. The requirement to double the stake on each successive loss will quickly put an account underwater;or blow it out completely. Trading this way will soon see you funding your broker.
Furthermore it is important to understand that the trader will only win one unit of profit i.e. even though huge risk is taken further along the progression, on winning, the account only goes back to parity.
Example: Each successive loss from 1 base unit sees the number of units wagered doubled. Successive losses would run as follows:- 2 units (1 loss), 4 units (2 losses), 8 units (3 losses), 16 units (4 losses), 32 units (8 loses) etc. Therefore the total amount wagered for 9 consecutive losses would be 256 units for one unit of profit (1, 2, 4, 8, 16, 32, 64, 128 and 256)
Paroli system is often referred to as the ‘Reverse Martingale’ or the ‘Anti-Martingale’ system. This is because rather than advocating that the wager is doubled up following a loss, it suggests doing the opposite.
The system works by setting out a progressive scaling up of the wager size following each win. When a win is registered the subsequent position is doubled. This is normally done for a maximum number of consecutive wins. Three is often recommended. A loss or reaching three consecutive wins sees the trader revert back to unit per trade until a win is recorded again.
Example: Each successive win from 1 base unit sees the number of units wagered doubled. Therefore following a win the units wagered would run as follows – 1 unit (1st win), 2 units (2nd win), 4 units (3rd win). At the third win the wagered units would revert back to 1.
As with many other money management systems touted for use with Binary Options, the D’Alembert system originates from world of gambling. It was devised by the French Academic Jean Baptiste le Rond d’Alemert (1717-1783) who had a fascination with both betting and mathematical theory.
As with many ‘systems’ it is best suited to ‘even money’ wagers. The system works by adding or subtracting a unit from the initial wager dependent upon the preceding outcome. Each time a loss is registered, a unit is added to the wager for the following trade. Alternatively if a win is registered then a unit is removed, subject to a minimum of one unit.
Example: Assuming a starting point of 1 base unit, an additional ‘unit’ would be wagered on the next trading opportunity (1+1=2 Units). If this contract lost then the wager would increase by a further unit (3). If the subsequent contract ended in the money, a unit would be subtracted. The wager would return back to 2 units (3-1=2 Units).
The above three money management strategies come straight from the Casino table. Most traders will therefore consider this high risk. Whether they are suitable for use with binary options is debatable, as most work best with ‘even money’ wagers. This requires a balanced risk to reward ratio for binary options which is difficult to achieve with the returns available on most popular contracts.
So should you make use of them? Well the way in which you manage your risk will ultimately come down to how you want to approach your trading. It should also take into account the strategies you employ and your appetite for risk. Yes, these systems can see you win back losses and accelerate your gains. However they don’t support long term performance. You will need not only need trading skills but also a run of luck if using them.
While it is hard to quantity what success you will have with them one thing is guaranteed: at some point, they will blow your account. :)