Slippage is one of those issues that new traders are often unaware of, but it can have a big negative impact on your profitability as a trader. Being aware of this drain on your account and taking steps to avoid it will allow you to boost your overall profit numbers as a binary options trader.
Let’s take a look at the issue in a little more detail, and see what can be done to avoid this often unnecessary loss of cash.
What is Slippage?
Slippage is a loss of money that occurs because of broker fees, spreads, or commissions. In the world of Forex trading, slippage is usually a pretty obvious factor in your trades. If you buy EUR/USD for a bid of 1.0700, the ask price is going to be a couple pips higher, probably around 1.0705 or so, depending on the broker that you use and the time of day. If you bought the pair and immediately sold it without any price movement, you wouldn’t break even, but would instead lose money because of the spread.
In the binary options world, the set up is different. And because a lot of brokers promise you no fees or spreads, it can be tough to discern just how slippage is going to happen. But slippage is one of the biggest issues that binary options traders face. It happens when there’s a significant difference between the amount you earn on a winning trade and the amount you lose on an incorrect prediction.
Example of Binary Slippage
If you take a call option out on the EUR/USD, you will earn the full rate of return if the price has increased at the expiration time, even if it hasn’t covered the spread. Let’s say your broker offers a rate of return of 78 percent, and the price increases a tenth of a pip. If you risked $100, you’ll see that full $78 returned to you.
But let’s say that the price drops by a tenth of a pip. If you had risk $100 (post-leverage) in the Forex market, you have lost only a fraction of a dollar when you close your position. You lost your money from the spread plus the tenth of a pip. It’s a loss, but not a huge one. In the binary options market, you’ve lost your full $100.
The difference between Forex and binary options is very noticeable now. When you are right in the binary options market, you are rewarded substantially. When you’re wrong, you are punished even more rigorously. Higher risk, higher reward.
But here’s the bigger issue: the discrepancy between the gains and the losses. If you are randomly trading, you are right 50 percent of the time. With a 78 percent return, you are actually losing an average of $11 at $100 risked per trade.
How to Beat Binary Slippage
The average binary options trader is not going to make random trades. Hopefully, their correct trade rate is better than 50 percent. But how much better does it need to be?
Start with what you know. What’s your rate of return? In the above example, we decided on 78 percent, but sometimes it will be higher, sometimes it will be lower. Next, pick an easy number (like $100) and an easy number of trades (like 100). Now, calculate your “breakeven” number. If you make 100 trades at $100 each with a 78 percent return, then this is the number of trades you’ll need to make to turn a profit.
A skilled trader can see a success rate as high as 65 percent or greater when looking at short term expires. Most beginning traders will hover just over 50 percent, though. Let’s say you’re somewhere in between these two extremes—what percentage should you aim for?
At a 58 percent correct trade rate, you are making 58 correct trades for every 100. 42 will be wrong, for an immediate loss of $4,200 if you risk a flat $100, and you will profit $4,524 for a total profit of $324. If you creep down to 56 percent, you’re suddenly losing money. This is a very fine line—that’s just 2 trades difference.
Risk Must be Smart
Traders have control over a few different factors. You have control over which trades you make and which broker you use. For example, why go with a broker that offers a high of 76 percent per trade when you can use one that offers 80 percent per trade? You are immediately giving yourself a raise when you find a higher return, with all other factors being equal. And who says you must always risk the same amount per trade? What if you risked more when you had a better chance of success?
This isn’t a new concept. It’s one that professional poker player have used for decades. When you have the bigger advantage, risk more. You might even already use this concept in your Forex trading. Because of the set numbers that many brokers have when you trade, varying your risk is not simple. But if you don’t do so, you’re at a big disadvantage.
Look at those 56 correct trades we made above. Given a flat $100 risked, you would have lost $32 over the course of 100 trades. Not because of bad trades, but because of slippage. By reducing our risk to $50 on each of the 44 losing trades, we’ve kept our correct trade rate the same, but cut losses from $4,400 to $2,200. Instead of losing $32, we have gained $2,168. That’s even better than the 58 percent correct trade rate.
Obviously, this is a perfect scenario, but the point remains: by understanding our odds of success and accounting for it, we can drastically reduce the likelihood of slippage hurting our profits. This is more of a money management technique than anything else, but it’s one that will allow you to turn the odds in your favor, especially if you have previous experience evaluating success in the Forex market.
Slippage occurs in the binary options market because you don’t make nearly as much when you’re correct as you lose when you’re incorrect. The brokers pocket that difference. And traders need to be very strong if they want to turn a profit at all. By varying your risk, you are giving yourself more of an edge, putting your money to work where it will help you the most.