Probably the greatest benefit of Binary Options for a new trader is that they are just so easy to understand.
There’s no need to set targets or stop losses, no need to calculate risk to reward ratios. You either win or you lose and you know your risk in advance. It’s easy to open an account with a small fund, it’s even easier to open a trade and there’s virtually no need to manage the trade once it’s opened.
And therein lies one of the greatest problems. It’s so easy to trade that it can appear as though the main difficulties associated with trading have been eliminated.
No so. Just because Binary Options are easy to trade they are no easier to trade profitably than any other form of trading.
Inexperienced traders soon see this. They also soon learn that you need a trading plan or a strategy if you are going to be successful.
But, it is seldom clear what comprises a trading strategy and so the internet is riddled with trading strategies that have little or no value to a trader.
I’ll use one ‘strategy’ that I seen repeated here and there as an example. Please be clear that I’m repeating it here not because I think it will work or that you should use it, but to illustrate a ‘strategy’ that will not work. It goes something like this.
Have a look at what the majority of traders expect to happen. Many brokers’ sites provide this information in the form of a percentage opinion so that, perhaps, 55% expect the Euro to fall against the dollar. Trade in the same direction as the majority.
Decide your initial stake. Let’s say $5. If the trade is a winner then go again with the same stake in whatever direction the majority are trading.
If it’s a loser then double your stake (or even triple it) and trade in the same direction as your initial stake. If you win then continue to trade in the same direction as the majority using your initial stake. If you lose, in other words you have had two losers in a row, then double your stake and trade again in the same direction.
Repeat as above once again. The odds of you experiencing 4 losses in a row are so low that you can be quite confident that you will now experience either a series of winning trades or a big win following a number of losses such that an overall profit is guaranteed.
Does that sound familiar? Is this a useful strategy?
You may at first think there is something useful here and it is quite easy to construct a series of trades that provide a profit here. But as a trading strategy this is total nonsense. Even worse, this approach is almost guaranteed to see you not only lose overall, but to see you lose all your fund.
The first problem is that a trading strategy must contain a way to help you to analyse the market and reach a decision regarding which market tot trade and in what direction.
Simply going with the majority – and it is far from clear what this means – is not market analysis. After all, most traders lose.
Without proper market analysis you are taking a trade with a 50:50 chance of success. As shown in the free eBook Introductory guide to Trading Binary Options, this is the route to losses. If you have not yet done so you should download a copy of this eBook by clicking here.
The second problem is that there is no proper risk control in this ‘strategy’. If you start off with a particular stake then it makes no sense to double it just because you lose.
Your odds of winning a trade are exactly the same irrespective of if it is your first of the day or your 99th of the day.
The odds are also the same irrespective of whether your previous trade was a winner or a loser. Each trade is independent.
If this is not the case and your chances of success have risen so that it is virtually certain, then why not risk everything?
In fact, this is what you will eventually do with this strategy. It’s a well known betting strategy known as a Martingale system.
At first the system appears attractive. If you have a 50% chance of success and the payout ratio is 100%, then if you double your stake after each bet eventually you will win and it is mathematically certain that your winnings will be sufficient to cover your losses and leave you with a small profit.
But, leaving aside the fact that you will not have a payout of 100%, the inbuilt assumption is that you have very deep pockets indeed.
Let’s say you start with a fund of $1,000 and an initial stake of $20 which is 2% of the total. Follow a Martingale strategy. After a run of 5 losing trades your next stake will need to be $640 if you are to be assured of covering your losses.
But by this stage your total losses will amount to $620. You cannot take such a big trade and so you are sure to have a losing strategy.
Even if you could fund the next trade you would be risking $620 on a 50:50 bet just to win $20 overall. That makes no sense.
But, if you have a 50% chance of winning on any trade then what are the odds of having such a long run of losses? In fact, the odds of losing 5 trades in a row are just 1 in 32. So you can expect it to happen quite regularly.
Are you really willing to follow a strategy where the odds are that you will be wiped out after just about 30 trades?
A proper trading strategy must contain four elements: risk control, a methodology to identify potential traders, a way to make a decision, and a process for monitoring and learning.
Putting on the trade is only a small part of any strategy.
Choosing the size of the stake is a vital part of a plan, but is not a strategy in itself.
Any strategy that suggests that you can be profitable when trading Binary Options simply by following a particular position sizing strategy will not work.
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