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You might be a seasoned trader, but you might find that Binary Options requires a slightly different mind-set. I had quite a bit of experience trading the Forex markets before I discovered Binary Options trading it took me awhile to adjust, because although you are still trading the same markets, you have to think about it slightly differently.
With regular Forex trading, you would be very careful to make sure that you place your stop loss in such a place that you don’t immediately get stopped out if there’s a spike, but also not so far away, that you lose a lot of money when the market goes against you, and then keeps on going against you.
The whole mind-set with traditional Forex trading is that you’re estimating how far the market is likely to move, compared to where you are placing your stop loss. You are hoping for a big rally, and no spikes, so that you can get out of the market with a lot of pips. Your risk to reward ratio is therefore based on how far you believe the market will move in the direction of the trade you placed.
The problem is that traders very often get trapped into moving their stops further away as the market moves against them, and closing the trade too early when the market moves in their favor. So they (not YOU, I know you’ve never done this, right?) end up risking too much, and losing money because you’ve moved your stop loss point further away from your entry point. Then when you do get into profit territory, you’re so scared to lose money that you’re all too happy to close the trade for a little profit. Does that sound familiar – don’t answer 😉
With Binary Options you do not think in terms of the risk versus reward ratio of your stop loss and potential target, the trading tip is for you to only think of time and market direction. Your job is to use your skill to estimate if the market is going to be higher or lower within the next ‘X’ couple of minutes (or hours).
Your only concern is with the direction and time, even if the market is one micro-pip in your favor when the option expires, you’re in the money. If you follow this trading tip you will find that your trading success will improve dramatically. That is why it is called “Binary Options”, you’re dealing with a binary yes/no choice within a set time-frame.
So what do you do in Binary Options when the market is clearly moving against you? The solution is called “fencing”, the term fencing is loosely used to describe taking an opposing position to your existing trade, but with the same expiry time.
This is way easier to explain with a chart, so let’s say that we enter the market here, at 1.10853 on the EUR/USD and we believe the market will be lower than the existing level by 08:00, which would be the expiry time we chose.
But then the market starts moving against us. You have no stop-loss in Binary Options, so what do you do? You fence it.
When you fence it, you take a trade in the opposite direction, so that it is on the other side of the “fence”.
You are going to take a CALL position to counter your previous PUT, and you are going to take it as close as possible to your original entry point to make your fence effective. In this case, we will take it at 1.10854.
Let’s say that you put down $100 on the first trade, and your return was set to 85% by your broker, that would mean that if the position wins, if it is “in the money” (ITM), you would get a total return of $185. However, if the market goes against you, you would lose $100.
Now, with a fenced trade, you would therefore lose $100 on the one trade, but make $185 on the other, leaving you with a net loss of only $15. Let’s see what happened in this case.
If you had been trading this without using Binary Options, you might have placed your stop-loss at 1.10895 (you might have placed it elsewhere, but let’s go with it since it is a support/resistance area). Given that you traded a standard single Lot, you would have lost $40, that is, if you didn’t decide to move your stop-loss a bit higher in case the market goes back down…
Also consider that in order to open a 1 Lot position on a regular Forex platform, you would need to have about $20,000 in your account in order to only risk 5% of your account and cover your margin. With Binary Options, you only need a $2,000 account because your $100 is your only exposure to the market.
With Binary Options you will also find that most brokers will allow you to close a position ahead of the expiry time, giving you the option to get a portion of your $100 (in this case) back. This option is not always available, but I have found that it is available most of the time, unless you’re doing something like 60 second trades or other very short expiries.
That’s about it for using a fencing strategy to limit your risk. Trade safe!