There are no real ‘secrets’ to becoming successful with your financial investments as some gurus would have you believe. There are however tested theories and best practices. Making good returns from trading with Binary Options is no different in this respect.
I have mentioned previously how many traders focus almost exclusively on strategies rather than money management when trying to achieve results. There is probably some justification to this as you will rarely see vendors touting the latest money management strategy as their latest eBook; although you can barely move due to the number of ‘new’ strategies released each month.
In a previous post I provided a brief examination as to why money management should form the ‘core’ of your trading. Here I want to look at another aspect of money management and risk control which is often overlooked. It is easily understandable, simple to put into action and can instantly boost your profits.
The Concept Of Compounding
Compounding is a power financial concept. It is simple to apply and can be used with any investment strategy. When used in conjunction with binary options it works particularly well. This is due to the short time frame that trading positions are run which speeds up its effects. This can make for some fairly spectacular gains over short periods of time.
It was Einstein who referred to the long term effects of compounding as the ‘greatest mathematical discovery of all time’ and this guy knew a thing or two about maths.
Compounding refers to making profits on your profits. It is no secret, although it is often overlooked. In fact the basis of long term Mutual fund growth and pensions make use of this concept at their core.
Let’s look at a simplified example to explain the concept: -
You have $1000 deposited in your trading with your broker. You place 5 trades, each using 10% ($100) of your capital. Each of these trades wins and you pocket a 70% payout from each one. You total account balance at the end of the week now stands at $1350.
The following week you place 5 more trades. Here again you use 10% ($135) of your capital. Again each of these trades wins (you must be doing something right!). With a payout of 70% on each winning trade you have now made ($135 @ 70% = $95 x 5) $475 profit.
What it is important to note here is that in both weeks you only ever risked 10% of your available capital on each trade outcome. However in week one you made a profit of $350. In the second week you made a profit of nearly $475 give or take a few cents.
This is of course just an example. You won’t finish in-the-money on every contract you place and the number of contracts you purchase will vary. However it is clear to see that by rolling up your profits you will quickly be able to place more on each contract outcome (without increasing your risk) and thus increase your binary options profits.
The compounding approach to trading is also referred to as creating a ‘snowball effect’. Over time as the snowball rolls down the hill it gets bigger. So too will your binary options profits if you follow this approach.
Take a look at the table below to see how you can compound your gains over a twelve month period.
Here again we have a hypothetical example. What it shows is both the effect that compounding has on both the grow of the money in the trading account and the size of contracts that the trader can purchase while balancing risk by only ever using just 10% of their trading capital.
Creating The Snowball Effect
To implement a compounding money management strategy you simply need to use a fixed percentage of your trading capital when trading. This is opposed to trading with a fixed stake i.e. monetary amount.
In the example above I used 10% of the available investment capital to provide an easy illustration. In practice you would be better to use say 5% of your capital per contract in order to lower your risks.You trade with this same amount of your trading fund for a set period. The exact time period will vary. If you are placing a lot of very short term contracts then you may want to recalculate at the end of each week. For most traders a month will probably work out best.
At the end of this period You then recalculate the total available trading capital in your account. Then just divide it by the amount you want to trade with and use this new amount for all trading contracts that you place over the next time period.
Remember that when using compounding you don’t need to take high risks to generate exceptional profits over time. You can take a longer term approach to your investment strategy. This means that you can lower your short term risks and still generate very good returns on your account.
By using a money management strategy for binary options that includes compounding you should be able to rack up some good returns in your account very quickly.