Diversifying your risk is a crucial requirement for long-term trading success. If you ask yourself, How can I diversify my risk in binary options? Here is your answer:
In binary options, there are three techniques to diversify your risk:
- Trading multiple time frames at the same time,
- Trading multiple asset types at the same time,
- Trading multiple indicators at the same time.
In this article, How can I diversify my risk in binary options?, we will take a closer look at each of these techniques. You will learn their advantages and disadvantages and how to use them. With this knowledge, you will be able to diversify your risk more effectively.
How can I diversify my risk in binary options? The guide
Let’s look at each technique to diversify risk with binary options individually.
Technique 1: Trading multiple time frames at the same time
When you make an investment, combining multiple time frames can help you to diversify your risk. To understand this technique better, let’s look at an example. The U.S. government has just published new unemployment numbers, and they are better than expected. You expect that the good news will cause the S&P 500, the main U.S. stock index, to rise.
There are a few different ways to trade this prediction:
- You could invest in the market’s immediate reaction, using an expiry of 60 seconds.
- You could invest in the market’s short-term reaction, using an expiry of 1 hour.
- You could invest in the market’s long-term reaction, using an end-of-day expiry.
Each of these strategies has its unique advantages and includes its unique risks. For the 60 seconds expiry, for example, you would expect the market to rise immediately after the good news become public knowledge. While that is usually the case, the market sometimes shortly retreats after its first gains.
This is because some traders are quick to take their early profits, causing the market to make a brief turnaround before it rises further and longer again.
Unfortunately, this short setback is unpredictable. With a short expiry, you always accept the risk of having your option end during the setback. To diversify your risk, you could combine the option with another option with a longer expiry, for example 1 hour or end of day or both.
If you combine all three expiries, you can reasonably expect to win at least two of your three trades, which would net you a profit. A good percentage of the time, you will win all three trades, making the same profit as if you went all-in on one expiry, but having the added security of a diversified risk.
Of course, you would have to reduce your investment per trade to one-third of the investment if you would trade only one option, but as a reward for the added effort you will be able to grow your capital more consistently and with less risk – you have effectively diversified your risk.
Technique 2: Trading multiple asset types at the same time
You can trade binary options based on assets of four types:
- Currencies, and
To diversify your risk, you can spread your investments over multiple types of assets, instead of focusing on a single type of asset.
When you focus all of your investments on a single type of asset, your risk increases because all of the assets of one type are interconnected. If there is some bad news about the economy, for example, all stocks are likely to fall. If you invested in rising prices, even if you spread your investment over different stocks from multiple types of industry, you might lose all of your investments. Similarly, bad news about the Dollar will affect almost all currencies, and you might lose a lot of trades because of a single event.
Because of how interconnected assets of one type are, diversifying risk within a single asset type can be deceiving. You might hold stocks from Europe, the U.S. and Asia, but bad news about a single market, for example a decline of the Chinese economy, can easily trigger all three markets to fall, thereby possibly wiping out all of your predictions.
Since the most influential news often comes as a surprise when everything seemed to go the other way, such surprises can cost you a lot of money.
To avoid losing a lot of money with unforeseeable surprises, you can spread your investments over multiple types of asset types. If you invest in stocks, currencies, and commodities, bad news about a single aspect of the market can never wipe out all of your trades. You have successfully diversified your risk.
Technique 3: Trading multiple indicators at the same time
To know which assets to trade, when to invest, and in which direction, you need some form of indicator. This indicator is your way of finding profitable trading opportunities and showing you what you should do to win a binary option. Indicators are an essential part of every trading strategy.
Unfortunately, every indicator has some flaws. Just like every type of human personality is ideally suited for some environments and completely out of place in others, indicators, too, can sometimes be out of place and incapable of making valid predictions.
Fortunately, all modern indicators have been refined for years and are relatively reliable. Nonetheless, investing all your money based on a single indicator might be a bit too risky. By using multiple indicators, you can diversify your risk.
If you are trading a news report about unemployment numbers with stocks, for example, you could use moving averages to invest in currencies. To effectively invest in all asset types, you only need two or three indicators that you use smartly.
The most effective of using these techniques is combining them. Spread your investment over multiple time frames, and over stocks, currencies, and commodities, and make sure to use more than one indicator to generate signals. Then you will have successfully diversified your risk, your trading will be much safer, and you will be able to grow your money more consistently and without the risk of dramatic setbacks.