Binary options are not for the faint-hearted. This is an all-or-nothing instrument. A trader invests their capital, hoping for a fixed return. The outcome depends on price movements. You predict if the price for your underlying asset will be below or above a certain level at a certain time. But what level of risk is acceptable?
Essentially, traders wager on ups and downs in the market. Since 2009, the concept has been expanded. Now, some binary options can be traded before expiry, which gives you a portion of full profit or full loss. Here is an overview of binary options available in India.
How Binary Options Work
These instruments are classified as derivatives. They may be tied to various underlying assets. There are binary options on commodities, stocks, currencies, bonds, etc. Trading conditions depend on the brokerage.
Here is how binary options work on a regulated exchange. Suppose, you chose instruments tied to a currency pair (EUR/USD). The financial result will depend on your answer to the following question: “Will the currency pair be priced above 1.2800 at 11:30 a.m. on September 1st, 2020?” This will define what you will bet your money (say, $100) on.
If you bet on the growth, and the price on September 1 is higher than 1.2800, you receive your payout according to the terms. For instance, the payout can be 70%, which means you get $70 in this specific situation. If you bet on a decrease, you lose your initial investment completely (making a $100 loss).
Rewards Versus Risks
Potential loss can never be higher than the initial investment. This is an important advantage. The payout is also fixed. Thus, the only thing that matters is whether the price rises or falls relative to the chosen level. You may conclude that binary options are relatively safe. However, there are a few subtleties.
These derivatives are not for rookies. They require an in-depth understanding of the marketplace. At the very least, learn the basics of Forex trading. This will allow you to determine acceptable risks more accurately. Risk assessment is a crucial element of any lucrative Forex trade you are going to be involved in. Otherwise, losses may be substantial.
General Risk Formula
Traders have fixed risks, which means failures bring no surprises. You know you will lose your entire investment if the prediction falls short. Thus, if you wager $100, you will lose $100 in the worst-case scenario. This is simple.
Loss can also be reduced via rebates. These are offered by some brokers. For example, a rebate can amount to 10%. This means you will only lose a chunk of your investment (90%).
Here is the formula for a $15 investment. You can calculate actual loss by adding rebate to the maximum loss. The actual loss equals -$15 + ($15 x 10%) = -$15 + $1.5 = $13.5.
How Much Risk per Trade?
It is advisable to risk a share of your available capital. Never put everything at stake. Most experts recommend staying within the 1-5% range. Let’s see what it means for a trader with $5,000 in their account.
In this case, the ideal acceptable risk per trade is $50-100 (1-2%). Of course, it is tempting to invest more and thereby gain more profit. However, losses are just as possible. There is no such thing as high return-low risk investment. The bigger your profits – the more daunting the risk.
Caution is paramount. Never go beyond a 5% risk on any position, no matter how confident you feel. Humans are irrational beings, especially when greed comes into play. Keep calm, start small, and let profits grow. A moderate but steady income is better than quick spectacular gains. Those who take unnecessary risks eventually wipe out their accounts.
Trade with Caution
The key advantage of binary options is the possibility of high returns. These instruments are relatively simple, as they are based on the yes/no choice. The outcome is all or nothing: you either win or lose your investment.
The fundamentals are the same for all underlying assets. Thus, choose the instrument you understand best. For instance, if you are a Bitcoin buff, consider binary options for the cryptocurrency.
Knowledge will help you predict future price dynamics. Conditions and risks are crystal-clear from the start. If you succeed, the instrument will bring a fixed return. If you fail, you will only lose your investment.
Generally, 5% is the largest acceptable risk per trade. Stay within the recommended range and learn as much as possible about trends in your chosen market. Knowledge is key to more accurate predictions and more frequent profits. While your broker may give rebates, these will only cover a fraction of your loss.