Motivated traders, whether at the beginning of their careers or firmly established in the craft, are always looking for potential ways to capitalize on the market. The Martingale strategy is one such method, especially for traders looking to shift their effort away from the focus intensive monitoring of entry signals.
The Martingale strategy is a system of trading based upon negative progression. This means that following a loss, traders who adhere to this strategy will increase their position size. More precisely, it advocates for doubling up after each loss. Ideally, this strategy takes place when there is a 50/50 chance of an outcome happening, in which there is no expectation of a win or a loss occurring.
The theory is based on the assumption that you will not lose forever. At some point, you’ll be able to break a losing streak and on that winning trade, you’ll make back all of the previous losses in that chain and profit the original trade value. However, this only works if you have enough funds to continue doubling up.
The obvious drawback to the Martingale strategy is that the potential profit is small while the risks grow exponentially with each double down.
As we stated above, the Martingale theory has an almost guaranteed rate of success if the adherent has pockets deep enough to weather what may be very long strings of losses.
Let’s take a look at the strategy in action by using a coin flip as an example:
Imagine you have $100 and you want to bet on a coin toss using the Martingale strategy. Before the first flip, you call tails and bet $10. The coin lands on heads and you lose the 10$. Next flip, you call tails again but the coin lands on head again. You lose $20 and now you’re down an additional $30 from your initial $100. The third flip with a $40 bet on heads, the coin lands on heads and you win back what you lost plus an additional 10$. After two losing tosses and one win, you come away with $110.
It’s obvious when looking at this example that after only one more losing coin toss, you would have run out of money to continue doubling up and therefore this strategy would be a loser. Therefore, unless you have unlimited funds to draw from, this strategy is highly risky relative to its miniscule payout.
The big difference between trading forex and betting on a heads or tails scenario is that forex prices trend, often with the trends lasting for quite a while. To deploy a successful Martingale strategy in forex, the goal is that with each double down, the price for an average entry lowers. As prices move lower, you will be able to break even with smaller rallies.
Another reason why the Martingale strategy is popular in forex is that the chances of a currency falling to zero are incredibly slim. Currencies may fall dramatically but unless a country decides to annihilate its currency, the value won’t hit zero.
Traders with a large amount of capital might also find the Martingale strategy appealing because it gives them the opportunity to gain interest in order to neutralize their losses. A successful deployment of this strategy would therefore involve borrowing on a low interest currency in order to buy a currency with a high interest rate.
As we briefly discussed earlier in the article, if the participant engaging in this strategy has unlimited funds in order to continue doubling down in the face of defeat, the strategy will likely ultimately work. However, since the bets increase at such a rate, most traders who use this strategy could find themselves facing a hole that their pockets just can’t manage.
The most important action for a trader to take when using this strategy is to define the maximum loss they’re willing to suffer on each trade. Engaging this strategy without taking this step is careless and strongly advised against.
The next preparation should be deciding to quit the double downs after the fifth repetition. If it doesn’t pay off after that attempt, look to trade other pairs.
After that, it’s wise to only deploy this strategy sporadically. We’ve outlined above how quickly big losses can pile up. Also, avoid using this strategy during a ranging market.
Lastly, like any well thought out strategy, it’s important to practice this one before going live in the market.
In theory, this strategy might sound great because it does seem to offer the inevitable win, even after a long string of losses. While this may be true, by the time traders see an eventual win, the hole they have just dug may prove to be too big to get out of. Only traders with large portfolios should attempt this strategy and even then, it’s extremely risky. Only try this if you are experienced and comfortable losing most of your account equity in a single trade. Otherwise, it might be wise to steer clear of this strategy.
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