Break Even Analysis for the Day Trader

The secret to day trading is to trade based on rules that are created with thorough and efficient break-even analysis. Break-even analysis can be conducted in various ways, and allows a trader to mathematically determine what percentage of trades must be correct given a specific risk over reward ratio. This ratio describes how much a trader needs to make, per trade, in order to account for commission costs and other fees. It also describes where the stock needs to be trading in order for an options trader to break even on the option. Whichever type of analysis you are conducting, determining break-even percentages, amounts, or points is an essential element to day trading.

Adjusting the Stop-Loss to Meet Your Needs

Calculating the appropriate break even percentages for a given risk-reward ratio shows a trader how many trades have to be right in order to be able to continue to trade using the same strategy. For example, if your stop-loss is ten cents, and you’re looking to make thirty cents on your accurate trades, you would have to be right 25% of the time in order to maintain that ratio. The calculation would be:

  • 10/30+10 = .25

If after time it seems evident that you are accurate 30% of the time rather then 25, you would only have to make twenty-three cents on each trade assuming a ten-cent stop-loss. Thus, break-even analysis can be constantly adjusted based on changing market conditions and increasing trade data.

Adjusting for Fees and Commissions

One thing that also must be considered when using this method of break-even analysis is the trading fees and commissions involved. If the first three cents of a trade go to commissions, then buying a stock at fifty cents means that you start profiting only once the stock moved past fifty-three cents.

The reality of looking to make thirty cents profit per trade, while only willing to lose ten, is that the stock will have to go up thirty-three cents. You will risk thirteen cents, ten plus three equals thirteen, once factoring in trading commissions. Thus, instead of needing to be correct 25% of the time, it will have to be 28% of the time. These types of adjustments for trading fees and commissions need to be factored into break-even analysis in order to trade in a mathematically efficient manner over time. 

Knowing the Break-Even Point of Each Trade is Vital to Success

As mentioned above, it is important to be aware of trading fees involved so that the true profit and loss that is being made on a given trade is known. For example, a five cent loss may in reality be an 8 cents loss, and a twenty cent gain might really only be a seventeen cent gain. Thus, if you have decided that you are only willing to lose five cents per trade, and commissions + fees represent three of those five cents, your leeway is very small. In a volatile market, it can be difficult to maintain a narrow point.

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