This lesson teaches what break even ratio is, how to calculate break even ratio, and why knowing your break even ratio is so important. This lesson includes several examples of break even ratios.
BO104 Lesson – Break Even Ratio Transcript
Welcome to another Binary Options 100 training video. This is Binary Options 104, Break Even Ratio. My name is Sam, and this course is brought to you by binaryoptions.education.
When we trade binary options, there’s obviously potential payouts and potential losses. If we place a call or put with a binary options broker and our speculation is correct and we win, we claim a payout from the binary options broker, which is a profit. Now, the payout percentage can range generally from about 60% 80% of our investment. So some examples would be 72%, 75%, 80%, et cetera.
If we were to lose– if we placed a call but price depreciated during the time of the binary option, or if we placed a put and price went up or appreciated over the time of the binary option, we would make a loss. And this is usually our entire investment. So if we placed $5 on our binary option, we could potentially lose that whole $5. If the potential payout was 80%, we could potentially gain $4 and receive $9 back, which would include our original $5 investment.
Potentially losing 100% of your investment is what creates one of the major risks in binary options trading. With other forms of trading, your investment generally appreciates or depreciates with price, and there isn’t this all-or-nothing characteristic. So to help us minimize this risk, we need to calculate a break-even ratio and ensure our winning percentage is above that break-even ratio. And you’ll understand more as this video goes on.
So what is break-even ratio? Break-even ratio is the amount of winning trades we need to place for our account balance to stay the same. So if we have a $500 account balance with our binary options broker and we place 100 trades, if our account balance is still $500 after those 100 trades, we have not made a profit or loss. Our account has stayed the same. And this is referred to as break even.
So if our break-even percentage was 55%– so if we made 55% winning binary options trades, we would break even. If we were making 60% winning trades, then we would make a profit. That 5% from 55% to 60% would bring us into profit, whereas even if we were winning 53% of the time and our break even was 55%, we would be making a loss. Even though we’re winning more than half the time, our break even is more than half– the reason being, the potential risk outweighs the potential profit.
The first step you need to take in developing a binary options trading strategy is to calculate a break-even ratio. You can then find a strategy who will provide a higher percentage of winning trades when compared to break even.
So how is break-even ratio calculated? We take our potential loss, which is usually 100, and we divide that by the potential payout plus the potential loss, and times by 100.
So if our potential loss is 100% of what we invest and our potential payout is 75%, we would take 100, the potential loss, divide that by the potential payout and potential loss, which is 175, and times by 100, which is 57.14%– meaning if we were right 57.14% of the time when trading binary options, we would break even. If we were right more than 57.14%, we would make a profit. And vice versa. If we were right less than 57.14%, we would make a loss.
So here are some examples of break even percentages. You’ll notice the potential loss on these bottom two is at 95– the reason being is some brokers do not take 100% of the investment. Some of them may only take 95%. So potential loss of 100% of your investment and a potential payout of 68% of your investment creates a break even of 59.52%.
A potential loss of 100% with potential payouts of 77 gives a break even of 56.5%. Potential loss of 100 against 82 gives a break even of 54.95%. And then we have two more calculations here for 95% potential loss.
So you’ll notice the smaller the potential loss and the higher the potential gain or payout, the lower the break even percentage should be, meaning we have to be right in our trading less frequently.