Types of Risks that Can Be Faced with Trading Binary Options
Although there is no way to completely remove all of the risks in any type of investment, having an acute awareness of the potential risks that may be present can help in reducing some of the uncertainty for traders. This alone can help traders to focus more on the actual investment at hand, knowing where certain pitfalls may lie.
Some of the potential risks that traders may face in the binary options market can include:
Market Risk
Similar to other investments, the trading of binary options can involve overall market risk. In nearly all cases markets can – and oftentimes do – move in various directions without ample warning. Although there are ways to predict potential market movements, even the most thorough of analyses cannot always accurately pinpoint exactly which direction the market will take.
Fixed/Capped Profit Amount
Another risk that binary options traders need to be aware of is fixed profits. In the case of these investments, both losses and gains are capped – meaning that there is no unlimited upside potential with these investments. On the positive side, however, losses are also capped.
Extremely Precise Profit and Loss Points
In addition, unlike many other investment vehicles, binary options are measured by the slightest tick. This means that oftentimes the value for this type of option may be determined by as many as three or four decimal points. With binary options trading, even 0.0001 points may mean the difference between a trader is on the profit or loss side of the investment.
Illiquid
Binary options are also not considered to be a “liquid” type of investment. Therefore, because these vehicles are not able to be exercised at will, traders must wait until the options expiry date before he or she can take their profits or losses.
Sparse Regulation
One of the biggest risks when trading in binary options is the fact that the OTC markets are currently not regulated. This means that even though most binary option trading platforms are as they appear, there is a chance that traders may run into some forms of unscrupulous practices.
How to Determine Risk on a Binary Options Trade
Binary options have a maximum fixed risk. This lets you know in advance how much you could lose if the asset (called the "underlying," which the binary option is based on) doesn't do what you expect. For binary options, the risk is the amount you wager on each trade.
If wager $10 on a binary options trade, your maximum loss is $10. Some brokers offer a rebate on losing trades; 10% for example. If this is the case, your maximum is only $9, calculated as:
maximum loss + rebate = trade risk
-$10 + ($10 x 10%) = -$10 + $1 = -$9
Nadex binary options don't have rebates on losing trades, but if you buy an option at 50, and it drops to 30, you can sell it for a partial loss, instead of waiting for it to drop to 0 (or move above 50, which would produce a profit). Ultimately though, at expiry, the Nadex option will be worth 100 or 0. Therefore, when determining your risk you must assume the worst-case scenario.
Nadex binary options trade between 100 and 0. With each digit representing a $1 profit or loss. If you buy one option at 30 and it drops to 0, you have lost $30. If you sell one option at 50 and it goes to 100, you have lost $50. You can trade multiple contracts to increase the amount you make or lose. This is a tutorial on position size, not Nadex options.
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