Break-even, or sometimes just breakeven, is actually an important concept within Forex.
It’s important for trading in any security, and for the same reasons. In fact, there is an entire trading strategy that works around it.
Going by the definition, it might seem like a simple idea, but there is an important implication for forex trading that comes from this concept.
Break-even comes from the Break-Even Point (BEP).
What’s that? Well, in terms of price action, it refers to the point where gains equal losses. Simple, right?
Hold on a Second
In Forex, there’s more to gains and losses than meets the eye. We have to take into account risk, because accounting for risk is part of the losses side of this equation that many people forget. How does that work?
So, first, you’ll probably have noticed there are two prices on your trading platform: the sell and buy price. When you enter the market, you get a difference from the price action which is the spread.
A Sample Trade
Let’s say you buy one lot of EURUSD, and your broker has a 2 pip spread.]
If the market is at 1.1120, and you buy, you’ll notice that you are $2 in the red. This is because now that you’ve bought, you now have to sell in order to close the trade. And the sell price is two pips lower, to account for the spread.
When the market goes up two pips, you’ll find your trade returns to 0.
With traditional bookkeeping, you might consider that as the break-even point, because if you close the trade, you’ll neither make nor lose money. Except that in order to open that trade, you had to take a risk, because if the trade didn’t go up again, it could have gone the other direction until it hit your stop loss.
So Where is the Break-Even Point?
There isn’t a universal number; it depends on your forex trading strategy and risk profile. But, a rule of thumb is to calculate how likely you were to lose on that trade.
For example, let’s say you set your stop loss at 100 pips, and your strategy has a 70% win-loss ratio.
That means there was a 30% chance that when you took that trade, you would lose 100 pips. In other words, if you iterate your trades over a long enough period, you will lose 30 pips on average per trade, while gaining an average of 70 pips per trade.
Those 30 pips are your cost of risk.
So, in order to find your “real” break-even, you have to consider your cost of the spread (2 pips), plus your cost of risk (30 pips), which would put your BEP on this example trade at 1.1152.
Considering this concept, it’s easier to factor in your profitability ratio over time and help keep your strategy producing a more consistent profit.