In business, you are set to ‘break even’ when you’ve neither made a profit nor loss after factoring in all the costs involved to produce a good or service. In many ways, trading forex is very much like a business.
The significant monetary aspect involved inherently means we quantify our results based on profits and losses. We know gains are positive numerically and psychologically, while losses are negative in both ways.
When a trader tallies up all their profits and losses over a particular period, they hope the end result is a monetary gain considerably larger than what they began with. Yet, a third element continually receives mixed reactions from traders globally: breakeven trades or, more specifically, using breakeven stops.
Trade management in forex is often overlooked in favor of picking the best entries in the markets. However, one commonly discussed method for managing your positions is breakeven stops.
There are numerous parameters to consider when traders should move their stop to breakeven. However, this article will cover whether you should be using this technique in your trading, along with the advantages and disadvantages.
What are breakeven stops?
A breakeven stop is a technique whereby traders move the stop loss of their current order to their entry point once the price has traveled positively above or below a predefined distance. This action aims to produce a ‘zero trade’ or a position where you are virtually guaranteed to incur no loss or profit.
Therefore, breakeven stops are a defensive course of action at their core. When you’ve entered into any trade, although the price might have favorably moved a sizeable distance, it can quickly turn around and move beyond your entry-level.
By using a breakeven stop, you’re protecting yourself from this possibility and ultimately preserving your capital.
The psychology of breakeven in forex
In most cases, the reasons traders move their stops to breakeven come from psychological relief. Although experts always recommend removing your emotions from any decision-making as a trader, it’s not always possible because we are humans at the end of the day.
For instance, a trader who experiences a losing streak of five trades might feel emotionally safe to move their stop to breakeven if it means they won’t commit any foolish mistakes in the future like lacking discipline, not sticking to their trading plan, etc.
Although this action might not be technically correct on paper, it could be the right thing over the long run.
Conversely, if a trader is performing well and hitting some big winners along the way, they wouldn’t be concerned about breakeven stops and would be content with stomaching a few losses here and there.
So, sometimes traders will alternate between using a breakeven stop on certain occasions and not using it all, depending on how they are performing at the time. The argument about using this approach isn’t always about statistics but rather about mindset or psychology.
Advantages of breakeven stops
The main benefit of this method is you theoretically remove the chance of ending up with a losing position.
A trader can also use breakeven stops in other scenarios. For instance, if one had a reasonable amount of floating profit, it might make sense to move the stop to their entry profit if the quality of the setup or signal deteriorated for whatever technical or fundamental reason.
At this point, the trader might forecast the market moving aggressively in the opposite direction, which is, of course, not going to be favorable.
Disadvantages of breakeven stops
The most apparent drawback of the breakeven stop is that you’ll be stopped out of your positions more frequently. In some instances, the trader will protect themselves from losses.
On the flip side, they’d miss out on good trades that might have turned out to be highly profitable. Many argue that a breakeven stop doesn’t necessarily offer you a ‘free trade’ or ‘playing with house money’ because the risk of being taken out of a potentially profitable position is still a risk in itself.
A common error caused by fear is bringing the stop to breakeven far too soon without adequately accounting for the natural fluctuations of the market. So, knowing when to move the stop to breakeven in a way where you’ve accounted for the volatility is challenging.
However, a trader will undoubtedly still miss a valuable position at some point by adopting this process. Therefore, the possibility of missing out on a few good trades is the sacrifice to breakeven stops.
Another way of thinking of breakeven stops in forex is the various outcomes to expect from any trade you take. It may not be beneficial to use an all-or-nothing approach where you either have a set loss or profit target at 2R, 3R, or other levels.
Even when you’ve been fortunate enough that price didn’t trigger your stop and is now well into profit, there’s still a grey area in between. You may ask yourself whether to exit the position at that point or let it run. By letting it run, you’re thinking in a binary fashion.
As already mentioned, the market will not always travel to your intended target or at least not in the time you wish. So, a better approach may be to quantify your trade outcomes as either set loss, small loss, break even, partial profits, and intended/big profit.
Having all these results as possibilities will undoubtedly require you to navigate the stop loss in the most logical way where you give the market enough time and room to move while defining a point where it may be best to exit.
So, ultimately, breakeven stops can protect you from losses but also prevent you from considerable gains as well. Therefore, no right or wrong answer exists. Just as the market is a highly dynamic environment, so are we.
Therefore, with the right experience and correct application, breakeven stops can be positive with a balanced approach.