Saturday, December 26, 2009

The Break-even Dilemma

Today I wanted to write a post about an aspect of trading which has always sprung a discussion between traders. This option of money management, the setting of a break even move, has been both praised and bashed by traders as a way to control the inherent risk on trades. Is it good to move your stops to break-even ? is it bad ? This post will try to go through both the advantages and disadvantages of the use of a move to break-even highlighting the importance of this choice in the particular money management strategy used.

So what is a move to break-even ? A move to break-even is when a trader decides to move his SL to a price level which is usually the entry price plus or minus the spread (depending on trade direction) to ensure that if price pulls back the trader will, in a worst case scenario, exit the trade with no loss. The move to break-even counts on price moving a given favorable number of pips before the actual move is done. Usually this move must be in the order of a minimum 10-15 pips depending on the broker.

As you may have already thought, the controversy of using a move to break-even arises when one considers that moving the SL to break-even cuts the "breathing room" from the trade. Traders will argue that many times the move to break-even makes the trades go back to take out the trade and then continue in what would have originally been a winning trade. However, moving to break-even does limit the loses in those trades which move in favor and then move back to move way beyond the break-even price and into the stop loss.

So is using a move to break-even good or bad ? This question is certainly not answered in an easy way. First of all, a very well statistical analysis of your system is needed. What percentage of the time does your system retrace to the SL after taking X profit ? Is this amount significant ? What percentage of the time does your system go to X and then return to levels below the entry only to go to the TP ? Taking a look at the chart of a 10 year backtest of your system may help you answer these questions as on very varied market conditions these are bound to change.

Some systems like the god's gift ATR in which the most profitable trades don't test levels below 70% of the ATR benefit from this approach (which is the first move of a trailing stop) while systems that usually oscillate before arriving at the final profit may not (systems like the turtle trading system). In my experience, the move to break-even is the "lazy" approach towards cutting loses short. It is a far more efficient approach to use an intelligent closing logic that matches your strategy rather than a break-even approach. A closing logic makes sure that trades are closed when there is a reason to do so and trades can usually be closed with a profit rather than with no profit at all.

Finally, the best way to know if a move to break-even is the way to go is simple. Implement it and see if it improves your profit in a 10 year simulation. Adjusting the amount of profit before break-even against the ATR may also be a good idea in order to adjust the moves according to market volatility. When manual trading, remember that moving to break-even should be a regular practice when you are trying to play moves in which there is a high probability of the market evolving against you (trading the news for example) or when your analysis tells you that the probability of the trade going against you is high but a good possibility of profit exists (like trying to trade a retracement on a trend).

If you would like to learn more about designing trading systems that can adapt to changes in market conditions and remain long term profitable please consider buying my ebook on automated trading or subscribing to my weekly newsletter to receive updates and check the live and demo accounts I am running with several expert advisors. I hope you enjoyed the article !

No comments:

Daniel Fernandez's Expert Author Email Alerts
Sign up to receive email alerts of Daniel Fernandez’s latest articles from!

Email Address: