In this article, we explore the origins of the Martingale strategy (or Martingale system), why it’s almost a sure bet and whether it’s worth the risks and rewards.
What Is the Martingale Strategy?
If you’re already familiar with forex trading, you may have heard of the Martingale strategy being referred to as the ‘zero expectation scenario’. Essentially, when you engage in a Martingale strategy, you double your trade size every time you face a loss. The idea is to bet with a 50% probability of having a successful trading outcome. Although it may not sound particularly French in origin, the Martingale strategy started as a class of betting tactics commonplace in 18th-century France. It was introduced by mathematician Paul Pierre Levy as a ‘doubling down’ betting strategy. In fact, you may have already played a Martingale strategy without knowing. A simple one is the famous heads or tails coin flip. The gambler wins when a coin lands heads up and loses if it comes up tails. The gambler doubles their bet every time the coin lands tails up. The idea is that the first win would be substantial enough to cover other losses within the bet. The chances are that the gambler will eventually flip the coin so that it lands heads up. The downside, of course, is that the gambler must have the funds to continue to a satisfactory outcome, much like forex trading. In a game of heads or tails, the gambler will not have an infinite amount of funds to bet with, and with that comes a risk of bets becoming bankrupt, hence term zero expectation. The expected value is zero because there is a 50% probability with each bet. Today, almost every casino across the world applies the Martingale strategy to bets.
How Does the Martingale Strategy Work in Forex Trading?
In a Martingale trading strategy, the trader increases the amount allocated for investments, even though its value may be falling, with the view that there will be a future increase. The strategy is no way near as simplistic as a game of ‘heads or tails’, though. The Martingale strategy has been modified several times for trading so that they are not quite zero-sum strategies. Let’s examine the following example. A trader decides to test the waters with a Martingale strategy, and they purchase company shares to the value of $20,000 when it is trading at, say, $200. The stock price of those shares then falls over the coming days, and the trader decides to purchase $40,000 worth of shares at $100, and the average share price goes up to $120. Again, stock prices fall, yet the trader doubles their purchase again to $80,000 at $50 per share. Now, the average price per share has reached the point where it is just below the trader’s initial bet size ($39.20), meaning the profit now equals their initial investment. The trader then waits for the stock to move to $39.20 and gains a profit of $20,000, which is the size of the initial bet. In the scenario above, the trader ceases trading after their third round of bets and still breaks even. However, this does not always happen and is an example for a very good reason. Trade sizes deploying a Martingale strategy can reach quite a considerable sum in the hope of recovery. That’s why it’s important that traders take risks they can afford. This is all well and good for general trading, but is the Martingale strategy profitable for forex trading? The answer is yes, it can be, but as with all trading strategies, it is not without its risks (more on this later). Let’s consider the forex trading scenario. In forex trading, you’re trading currencies, and so the trends typically tend to be long term. So when your trades are on the up, it can last a while. With a forex Martingale trading strategy, you essentially lower your average entry price every time you double your bet. For example, you need to rally two lots of Euros (EUR)/US dollars (USD) from 1.181 to 1.182 to make sure you do not fall short of your initial trade. Then, as the exchange rate lowers, you ‘double down’ and purchase four lots. You now need 1.8095 instead of 1.182. As a rule, within Martingale forex trading, you draw down the average entry price each time you double your lots. However, as we have all seen during a global pandemic, the strategy is not without risks, as currency markets remain volatile.
Is the Martingale Strategy Profitable?
The answer to this question largely depends on who you ask and when. It’s widely accepted that Martingale trading does not perform very well in trending markets in the long run. Low returns mean that the trade size needs to be substantially bigger than capital for carry interest to be truly successful. This is very risky business with the Martingale betting system. That said, the Martingale strategy is less precarious in forex trading than it is in stock markets. The reason for this is that currencies very rarely drop to zero. Although, a currency may fall in value, which can be quite sharp and unexpected. The forex market can be quite attractive to Martingale betting system traders who have considerable capital. They can use earned interest to compensate for some of their losses while waiting for a trade to turn in their favor. The advanced Martingale trader will usually use the Martingale system in the positive carry direction of currency pairs. They enter a positive carry on the theory that the currency at a higher interest rate will either remain static or appreciate. Essentially, they are doing what they can to try and influence a successful Martingale strategy by trading currency pairs with large interest rate variances.
How to Use the Martingale Strategy
The strategy behind Martingale trading is quite simple. In trading terms, it’s a form of negative progression that involves upping (in this case, doubling) your position size every time you make a loss. Eventually, you end up recouping your initial bet. If you are trading on a forex platform, you will need to do your research to identify the currency pairs you wish to trade on, initially with small lot sizes. Using a reputable forex trading platform, open your trade by setting your profit and stop loss. Next, you’ll need to wait for the trade to take place. If Given that the Martingale betting system is not without its risks, there are a few things that you can do to improve your chances. These are:
Take the time to familiarise yourself with Martingale forex trading by practicing with a demo account. You will get to practice trading in a real environment without taking any risk. Keep your ‘doubling down’ to a minimum. Try not to exceed more than five trades. However, this primarily comes down to funds and individual risk. Try and use the Martingale strategy within a ranging market where the chances of being stuck within a currency pair trend for an extended period is less. Most importantly, always specify the maximum loss you are prepared to take per trade (make sure you set your stop-loss). Keep the size of your trades proportionally small in comparison to your capital. This may feel unnatural for a trader, but it’ll enable you to endure the higher trades later in the cycle.
What’s the Reverse Martingale?
Now that you’ve grasped the concept of the Martingale betting system, you might want to explore the reverse Martingale strategy in forex trading. For want of a better description, the reverse Martingale is the anti-Martingale method. Instead of doubling a bet with each loss, you halve a bet every time there is a trade loss and double it each time you make a gain. It’s quite literally the opposite of the Martingale strategy. How is it different from the standard Martingale trading system? Well, it’s supposed to amplify winning. It enables a trader to take advantage of their winning trend by doubling their position. The reverse Martingale technique is often used by experienced traders who want to capitalize on their position by doubling up on a few winning trades before there’s a downturn. When there is a loss in a reverse Martingale forex trade, a bet is essentially halved. This means that the trader applies a stop-loss Martingale system, which is generally accepted as a more prudent strategy.
What Are the Risks of Using the Martingale Strategy?
The Martingale strategy is known to improve a forex trader’s chance of winning. However, it also has several drawbacks that make its use less appealing. For a start, the amount risked on a trade is exponentially higher than the gain. In no time at all, trading can reach staggeringly high proportions using the Martingale strategy. If a trader runs out of funds, which can and does happen, and they exit a trade while on a downward turn, the losses can be incredible. If you think about the risk-to-reward value of Martingale trading, its rewards are not that appealing, even if the probability of losing is low. This is because even though you may be raising your stakes at every bet, which can run into the many thousands, your final profit is only ever equal to the initial bet. Moreover, you’ll have transactional costs to consider too, which you’ll have with every trade you make. So technically, even if you break even, you will have ‘lost’, even if it’s by a small margin.
Final Thoughts
Regardless of its inherent risks, the Martingale strategy certainly has its place in forex trading. Many highly experienced forex traders have dabbled in Martingale trading and have gained a tremendous amount of market insight in the process. If you want to explore the Martingale forex approach fully, the best place to start is with a demo account on a forex trading platform. Then, you will be able to test your knowledge and strategies in a risk-free trading environment. Remember, the Martingale system does not increase your chances of winning. Usually, your return will eventually be the same as what you invested. As with any forex trading, your success is dictated by your ability to identify trades on currency pairs, and there’s no way of sidestepping that. Our advice with any new trading strategy is to do your research. Take up the demos, find the right platform for you, engage in courses, listen to podcasts, speak with experienced traders and read as much as you can. Most importantly, know the level of risk you feel most comfortable with! WikiJob does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.
