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The Break-Even Point

Once a trade is entered, there are two possible outcomes: Win or lose. Between the two is the break-even point, and because it is in-between, it's psychologically significant. Losing is involved with fear and hope. Winning is involved with greed.

When on the losing side of a trade, the break-even point is a place that inspires hope. Being human we have a natural tendency to avoid risk and loss. When in the agony of a losing trade, we tend to hold on and hope that the losing trade will turn around and return to the break-even point, where there may be no profits, but at least there are no losses. But hoping often leads to losses in the end. Hope has no place in making trading decisions. The entry point and the protective stop should be determined before putting on a trade. When this is done properly, there is no reason to let hope, or any other emotion, influence your trading decisions. You should trade almost mechanically. If the trade goes against you, simply exit once the stop price is hit. Don't let hope play a role in your trading plan.

There are many good reasons to cut your losses, rather than hope for the losing trade to turn around.

The point of view from a winning trade is quite different. When in a winning trade, traders tend to take all their profits too early, again because they are averse to risk and potential loss. By exiting the entire position too early they don't let their profits run. This limits the size of the winning trades, so that across a series of trades, the overall profit is greatly lessened. But there's a way to lock in profits, let the trade run a little longer, and pile on a little more profit. Once the profit exceeds the initial stake, a stop can be placed at the break-even point. This strategy lets you lock in some initial profits while virtually eliminating risk. The most you can lose is commission costs. Besides reducing financial risk, the emotional stress is also eliminated. And reduced stress means you can evaluate the bigger picture more objectively.

Unfortunately, many novice traders are so consumed with capturing a profit and showing a green profit/loss statement that they cannot follow through with moving the stop to the break-even point. They feel the strategy inhibits them and may limit their potential profits. They wrestle with moving the stop back to its original point, where they entered, or simply canceling it altogether. This can be disastrous to a trading account. Stops should never be changed to a more harmful position or cancelled altogether. Such practices will stir up emotions that adversely affect trading decisions, and eventually lead to the end of a trading career. Discipline is always the best strategy.

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Sunday, 14 July 2024

Derivative transactions, including futures, are complex and carry a high degree of risk. They are intended for sophisticated investors and are not suitable for everyone. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results, and all of which can adversely affect actual trading results. For more information, see the Risk Disclosure Statement for Futures and Options.