Some traders say that you should never move your stop loss to breakeven and others say that you should do it on every trade.
So who is right?
Well they both are.
I know of professional traders who move to breakeven and I know others that don't.
Every trader needs to figure out if moving to breakeven will fit their trading strategy, the markets they trade and their unique psychology.
In this tutorial, you'll learn when you should move your stop and when to leave it alone.
The best solution will be different for everyone, so you need to figure out what works best for you.
I'll also show you a couple of ways of moving to breakeven and beyond, that can make your trades more profitable.
Let's do this…
What Does it Mean to Move the Stop Loss to Breakeven?
If you're new to trading, I'll quickly define moving a stop loss to breakeven and give you an example.
In trading, moving a stop loss to breakeven refers to the practice of adjusting the stop loss level to the trader's entry price, plus a little profit to cover costs like slippage, the spread and commission. This is done after the market has moved in a profitable direction and ensures that the trader will not lose money on the trade, even if the market reverses.
The idea behind this tactic is to create a situation where a trade is risk-free.
Example
Here's an example of a trade setup.
This is a long trade, entering at the current candle.
The red bar at the bottom of the box is the stop loss and the green bar at the top is the take profit.
Once price moves in my favor, I can set the stop loss to breakeven by moving the stop to the entry point.
I usually move Forex trades to the opening price, +3 pips profit to account for any slippage and fees.
This is now a risk-free trade.
So if the trade reverses, like shown below, I would not lose any money on the trade because my stop loss would be at the breakeven point.
Now that you understand how to move your stop loss to breakeven, here are the benefits and downsides of doing this.
Benefits of Moving Your Stop Loss to Breakeven
When you move your stop-loss to breakeven, you do more than ensure that you won't take a loss on the trade.
You also free up your mental capital to find another opportunity.
Mental capital is the “space” that a trade takes up in your brain because you're worrying about managing the trade and if you will take a loss.
Moving the stop to breakeven takes the pressure off your trading because the trade is now risk free and you don't have to think about it anymore.
This allows you to focus your attention on finding and managing new trades.
Let's say that you have 5 open trades that will either lose 1% per trade, or make 2% per trade.
You then decide to move the stop loss on all of them to breakeven.
Once you do that, the worst case scenario for these 5 trades is that they will all get stopped out at zero profit…and also zero loss.
The best case scenario is that you will make 10%.
So you can see why some traders find this technique so attractive.
But of course, there is a trade off to this benefit.
The Downsides of Moving Your Stop Loss to Breakeven
The downside of moving your stop loss is that it's more likely that your stop loss will get hit often and you'll lose out on profits.
Just like the ocean, markets have a natural ebb and flow.
So it's best not to move your stop too soon because your stop is much easier to hit and you won't give your trades enough room to “breathe.”
As the saying goes: scared money don't make money.
Here's a common scenario, especially for beginners.
You enter a trade and the trade is profitable right away.
Since you lost your last three trades, you decide to make sure that you don't lose this trade too.
So you think you are doing the right thing and move your stop to breakeven.
Party time!
As soon as you open a drink…you get stopped out.
Then the trade goes 500 points in the profitable direction.
Doh!
This leads to second guessing yourself even more, which will affect your confidence and profit on future trades.
No bueno.
Move your stop loss too soon and you'll break even a lot.
What this can mean is that your winners won't make up for all of your losers because many of your winners are breaking even.
If that's the case, then your strategy will not have an edge and will lose money.
Of course, it also could be possible that you're dodging some losing trades too, which brings me to my next point.
How to Tell if You Should Move Your Stop Loss on Profitable Trades
Not all trading strategies will work well when the stop loss is moved to breakeven, so it's time to figure out if this is for you or not.
Remember that there are 2 potential benefits to moving your stop loss:
- Greater peace of mind because your trades are now risk free.
- An increase in profitability of the strategy because the strategy has fewer losing trades.
In addition, if you are going to move your stop loss to breakeven, you must:
- Do the same thing on every trade: You cannot move to breakeven on some trades and not on others. Not following a well defined plan will lead to inconsistent and unpredictable results.
- Decide on the minimum amount of profit that you should have before moving your stop loss: This could be 1 times risk (1R), or a certain percentage profit on your account. Whatever it is, it must be applied consistently.
- Backtest your trading plan: This will show you exactly how much moving your stop loss will affect your profits.
Trading strategies that will generally benefit from moving to breakeven are:
- Longer term trading strategies (4 hour chart and higher) because it's less likely that the breakeven stop loss will get hit by normal market movements.
- Trading strategies that have a trailing stop loss because they can make up for lost profits caused by moving to breakeven, by extending the profit on winners.
These are not set-in-stone rules, but just general guidelines, based on what I've seen in my own backtesting and the results of others.
Another thing to consider is that you might want to reduce the overall profitability of a strategy, in exchange for the psychological benefits of that come with moving to breakeven on profitable trades.
Not all decisions in trading have to be profit driven.
Sometimes you can give up a little profit for greater mental clarity.
When your mind is clearer, you'll usually make better decisions.
Now if you decide that moving to breakeven is a strategy that you want to explore, then it's time to do some backtesting.
How to Backtest Moving Your Stop Loss to Breakeven
The primary question that you want to answer with backtesting is:
Will my trading strategy generate enough profit if I move all trades to breakeven, after they hit a certain amount of gain?
So first, create a trading plan without moving your stop loss.
Then backtest that trading plan and find out what your baseline performance is.
My favorite backtesting tools are listed here.
Look at stats like:
- Win %
- Maximum drawdown
- Average profit per month/year
- Average winning trade in $
- Average losing trade in $
- Maximum number of losing trades in a row
Example stats by NakedMarkets.
Then create a new trading plan where you move the stop loss to breakeven after X amount of profit.
The profit could be measured in:
- Pips, points or dollars, depending on what market you're trading.
- A multiple of risk, so 1R would be 1 times risk. In this case, if your stop loss was 100 pips, then your move-to-breakeven target would be 100 pips.
- Percentage of your account. For example, once you hit 1% profit, move the stop to breakeven.
Of the options above, I've seen the multiple of risk method work best and it's the easiest to calculate.
It's also the easiest to automate, if you want to do that later.
A professional trader I know of uses this tool to move his stop to breakeven and automate a trailing stop.
So I'll use risk multiple from now on.
If you don't know where to start, move your stop loss to breakeven once price hits 1R.
Then backtest your strategy by applying this rule to all of your trades.
Once you're done, compare the stats listed above, before and after your change.
Experiment With Your Settings
If your strategy is acceptable after the change, then you're good to go.
Move on to the next step of forward testing your new strategy.
However, if your strategy was not profitable enough, then it's time to do some experimentation.
Here are some things you can try:
- Move your stop loss to breakeven at a smaller profit. For example you could move your stop when price hits 0.5R.
- Move your stop after you have a bigger profit, 2R for example.
- Only move your stop after a certain number of pips or points.
- Use an indicator to determine when to move your stop. You could use something like a moving average. Experiment with only moving your stop loss if price closes above a certain moving average.
Again, I cannot give you a blanket solution that will work for every trading strategy and every market because there is so much variation.
Therefore, you need to put in the work to figure out what works best for your situation.
Forward Test Your New Strategy
Even if your new strategy looks good in backtesting, it's a very good idea to trade it in a demo account for at least a couple of months.
This will show you how deal psychologically with the ups and downs.
A trading strategy can look good on paper, but may not fit your risk tolerance.
So further testing in live market conditions will help you understand how the change will impact your mindset.
Going Beyond Moving to Breakeven: Trailing Your Stop Loss
Trailing your stop loss means that you move your stop loss to lock in profits as price moves in a profitable direction.
Here's what that looks like on a chart.
In effect, moving your stop loss to breakeven is a type of trailing stop.
However, you can take this one step further and see if you can move your stop loss periodically while the trade is open.
Using the 1R example, you could move your stop loss forward 1R every time price moves another 1R in your favor.
There are also many other techniques and indicators that can be used for this purpose.
Obviously, you should test this method extensively before using it in a real money account.
The only thing to avoid when trailing your stop loss is the default trailing stop loss that many brokers provide.
In my testing and research I have not found a viable use of this type of trailing stop.
Final Thoughts
The bottom line is that you need to test to see if moving your stop loss to breakeven will help or hurt your trading strategy.
Your strategy, market and mindset must be a good fit for this trading strategy.
You may discover that moving the breakeven is not a good fit for you.
But if you stay aware, keep an open mind and work hard, you can figure this out.
Anyone can.
Now go test some ideas!
