Money Management – How to prevent overtrading?

Money Management – How to prevent overtrading?

What is overtrading?

As is stated in many articles of our education centre, money management is an important aspect in becoming a successful trader on the stock market, particularly binary options.

The greatest enemy of successful trading is overtrading, which simply means that you place too many trades.

Overtrading is a result of greed or panic and is totally human. It is a well known and proven fact that people are more afraid of risk than of lower profits. Simply stated, the thought of losing something is many times more painful than pleasurable thought of winning something. This is in our human nature.

Causes of overtrading

The same is true when we look at trading on the stock markets, especially if we look at binary options. The causes of this are the short expiry times offered by the brokers (60 seconds, 5 minutes, etc.) through which it seems that literally every minute a new trading opportunity appears, even when there simply is not.

Binary options are often advertised as a simple game, where it is possible to make money fast with short-term binary options. This impression of binary options being an easy games leads traders to opening one trade, then another, then another, etc., and this is overtrading.

Overtrading will cause you to lose and when this happens people will start to trade even more because they want to make up for their losses (chasing losses) which will eventually result in losing everything you have on your account.

Overtrading results in financial loss but the biggest cost of overtrading is the loss of confidence. A lack of confidence in your analysis is far more damaging in the long run than losing one or two, or even three trades.

How to prevent overtrading

There are two moments at which overtrading might occur and both can be prevented.

The first situation arises when an option hits your entry price and the option is out of the money but not yet expired. Often, binary option traders have a tendency to open another trade in the same direction and sometimes even with a higher bet than the first option. If the market than moves against the original price, this will cause losses for both options.

While this sometimes does work, by increasing the amount two or three times, in the long term it is just the same as a Martingale approach which will ultimately always fail.

Developting clear money management rules and sticking to them is the only way to avoid these kind of situations and a method to do so is to thoroughly study the assets in which one invests and to carefully set the expiry times.

It is well known that binary option brokers offer end of the day, end of week, and end of month expiry times on higher / lower options. The fact that binary option traders use it infrequently is because people want quick profits and don’t want to wait for binary options to expire.

An end of month option however, does not always mean that one has to actually wait one month. If it is already the 25th, one need only wait a maximum of 6 days. First you choose an asset to trade, then you check the economic calendar to determine if there is a big likelihood you will be making money buying or selling binary options.

Classic example

As an example, we assume the stock market is volatile because the Federal Reserve of the United States has announced to raise interest rates. What you should do now is follow US Dollar related events and in case of confirmation (actual print is above expectations) buy call options on the US dollar and set the expiry time long enough so that the FOMC’s publication is earlier than the expiration date. This was an example of an almost 100% guaranteed successful binary option trade.

Another way to avoid overtrading, is to avoid trading currency pairs which have a direct correlation with each other. For example, if someone buys GBP / USD (call options), it really doesn’t make sense to buy call options on EUR / USD as long as the “cable” pair is in the money, and a move will effectively lead to a hedge of the initial position (as if you take 100 Euros to the casino and bet 50 on red and 50 on black, makes no sense!).

On the other hand, if the initial trade moves in the opposite direction, and the EUR / USD reaches a strong support (in case of a call option) or resistance (in the case of a put option), then it is useful trade a correlating currency pair.

  • Read other articles in our Education Centre
  • Read specific binary option strategies in our binary option strategy catalogue

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