Author: Consultant Finmaxfx

If you’ve been in the forex trading for a while, you must have come across Martingale strategy. But what is it, and how does it work? In this article, we take a look at the procedure, strengths, and real-world examples of how it is used in the real world.

There are some good reasons why such a strategy might be attractive to traders. First up, it does give a predictable outcome under certain conditions.

Next, traders are not required to have the ability to predict market direction. If you have deep pockets, it does work, especially when your trading skills are dependent on chance alone.

Lastly, since the currencies trade in ranges over some time, such levels are always being revisited. That behavior, then, suits the strategy.

What Is The Martingale Strategy?

The Martingale strategy was first introduced in the 18th century. Martingale was, initially, a betting style, which is based on the idea of "doubling down." The mechanics of the Martingale system involve an initial bet. But every time the bet is lost, the wager is double so that, on a long enough scale, a single winning trade can cover up all previous losses.

The 0 and the 00 were introduced in the roulette wheel to break this Martingale method. This gave the game two additional outcomes other than just the odd-over, or the red-black ones. Thus, the long term profit expectancy negative and took away any incentive of using this strategy.

To learn the basics, let us take an example. Suppose we are engaged in a betting game of coin toss outcomes and start our wager with \$1. The probability of the coin landing on heads or tails is equal. Each flip is independent and does not impact the outcome of future flips. Given that we engage in the same directional view every time, we would eventually see the outcome come out as heads and gain back all the losses, plus an extra dollar. The strategy is based on the idea that you need only one profitable outcome to recoup all your losses gain the extra bit from the profitable outcome.

Trading with a Martingale method is based on a negative progression system that calls for an increase in position size after a loss. In other words, you double down your trading size once you lose. A typical scenario is when one tries to trade the outcome with a 50% probability of it occurring. There is zero expectation with such a scenario.

For such a 50-50 scenario, there are two schools of thought about how to size one's trade size. Martingale involves the double down trading strategy when you lose while the anti-Martingale strategy involves increasing trade size upon winning. When you are on a winning streak, anti-Martingale money management works.

Martingale With Two Outcomes

To understand the Martingale strategy binary options, let us consider a trade with two outcomes, A and B, of equal probability. The risk-reward is structured at 1:1. Let us assume that you trade a sum of \$5 for outcome A, but instead, outcome B occurs, and you lose the trade.

On the next trade, you increase the size to \$10, hoping again for outcome A. Again, let’s say, B occurs, and you lose the trade. Double up again and trade \$20 for outcome A. Make sure that you keep doing this until your desired outcome occurs. When it does, the size of the winning will exceed the combined losses of all previous trades.

The key problem with Martingale is that winnings are guaranteed only if you have deep pockets to keep funding your doublings. However, this is usually not what you would expect with most traders. All traders have a limited capital that they can risk.

The probability that you will not make a profit is infinite. But when you do win, your original trade size helps you profit. The theory sounds good. The problem with such binary options winning Martingale's strategy is that you can only make a small profit while the risks are much larger for chasing that small profit.

For the example mentioned above, we are going for a \$5 profit. But after only three losing traders, we are already putting \$40 on the line. If the losing streak persists, we would be risking much more. If there is a loss of six in a row, we are risking \$320 for our paltry initial goal of \$5. Although the chances of ending up with a losing streak of six losses are small – they are not improbable.

They are actually greater than 1%. What would have happened if we had only \$200 to wager with in total? We would be forced to quite with huge losses. Such is the problem with Martingale. The odds of winning are guaranteed only if one has enough funds to keep doubling until one wins. This, of course, is not the case often.

The longer you use the Martingale trading strategy, the greater the chances that you will have a losing streak. This can be quite an off-putting proposition, depending on your mindset. Regardless Martingale does have its supporters.

Stay Away from “Trending” Currencies

Many people suggest using Martingale to trade pairs with high-interest rate differentials, for instance, with pairs such as AUD/JPY. The basic idea is that rollover credits can accumulate with large open trade volumes.

At the same time, there are some problems with this approach. Currency pairs that have carry opportunities are likely to follow strong trends. Many of these instruments observe corrective periods that are very steep as carry positions unwind. Such things can occur without warning, especially when there has been an unexpected change in interest rates.

The close analysis highlights that Martingale is not an effective strategy in trending markets over the long term. The low yields also mean that the size of the trade needs to be quite big concerning the capital to allow the carry interest to make any noticeable difference to the outcome. But the risk is too high with Martingale. Instead, it is better to use 3 step reverse Martingale.

Using Martingale as a Yield Enhancement

Most people say, and rightly so, that Martingale shouldn’t be used as the chief trading strategy. The reason is that for it to work, one needs to have a huge drawdown limit compared to the trade size. It's possible that when one is using a lot of trading capital, one can go broke quite quickly on the downswings. Instead, a modified use of Martingale is its use as a yield enhancement.

Pairs trading in tight ranges has the least risky trading opportunities. There are various volatility tools that one can use to check trends and current market conditions. Usually, the pairs that have long range-bound periods are the best pairs upon which this strategy can thrive.

Only when there is sufficient pullback can Martingale betting theory survives. It is important then to look out for new trends breaking out, especially around the critical resistance/support levels.

Let us assume that you have a capital of \$10, and your first wager is \$1. You bet heads, and you end up winning \$1, bringing your equity to \$11. Every time you wing, you keep betting the same \$1 up until the moment you lose.

The next toss is a loser, and the equity is brought down to \$10. On the next bet, you bet \$2 with the hope that you can recover your previous losses and bring your net profit and loss to zero. However, the bet is lost again, and another \$2 is lost, bringing the equity to \$8. IF you are applying the Martingale strategy, your wager should double your previous wager to \$4. Fortunately, you win, and you gain \$4, and your equity jumps to \$12. All that was needed was one win to recover the previous losses.

Here is an illustration that highlights the Martingale strategy in action. However, let us consider what happens when there is a losing streak. Trading pairs that tend to have strong trending behavior can be very risky. Below, you will find an example of the yield enhancement strategy that covers three months and produces a 9% return. Drawdown is kept within manageable levels due to the low average here.

Examples of the Martingale Strategy in Action

Let us assume that you have a capital of \$10, and your first wager is \$1. You bet heads, and you end up winning \$1, bringing your equity to \$11. Every time you wing, you keep betting the same \$1 up until the moment you lose.

The next toss is a loser, and the equity is brought down to \$10. On the next bet, you bet \$2 with the hope that you can recover your previous losses and bring your net profit and loss to zero. However, the bet is lost again, and another \$2 is lost, bringing the equity to \$8. IF you are applying the Martingale strategy, your wager should double your previous wager to \$4. Fortunately, you win, and you gain \$4, and your equity jumps to \$12. All that was needed was one win to recover the previous losses.

Here is an illustration that highlights the Martingale strategy in action. However, let us consider what happens when there is a losing streak. Again, you have a total of \$10 to wager, and your initial bet is \$1. In this case, you lose the first bet, and the equity is brought down to \$9. Doubling the bet on the next wager doesn’t help, you lose again, and equity is down to \$7. On the third bet, you bet \$4, but the losing streak continues, and you are left with \$3. Now, there isn’t enough money to double down. The only option remaining is to bet it all. With a loss, you are broke. Even when you win, you are still a far cry from the starting \$10.

One might be tempted to think that long losing streaks can be attributed to unusually bad luck. However, when trading currencies, these losing streaks can trend, and these trends can last for a long time. The thing with Martingale is that, when applied to trade, you lower your entry price when you double down.

In the above example, you would want EUR/USD to go from 1.263 to 1.264 to break even. Once the price lowers and you add four lots, you need the pair to rally to 1.265 rather than 1.264 to break even. The average entry price lowers as you add more lots. If the price hits 1.255 on the first lot and you lose 100 pips, you need the pair to rally to 1.2569 to break even.

This is one of the reasons why a considerable amount of capital is needed. If you have only five thousand dollars for trade, you would be broke before the currency pair reaches 1.255. The pair may turn. However, the biggest downside of the Martingale is that you may not have capital enough to stay in the market to see that.

Why Martingale Works Better with FX

Martingale system forex is popular because currencies rarely drop to zero, unlike stocks. Even though many companies go bankrupt and you may lose on Martingale stock trading, countries do not. Of course, there are times when the currency is devalued. However, even in times of a sharp decline, the value of the currency never gets to zero. The value of a currency can get to zero, but it would take a real global economic upheaval for this to happen.

There is one unique advantage that forex markets give to traders who have capital enough to follow the forex gambling strategy. Earning interest makes it easier for traders to offset a chunk of their losses. The best Martingale strategy then would be traded on currency pairs in the direction of the positive carry. Put simply, such traders would buy currencies that have a high-interest rate.

If you like this strategy, you might also be interested in this ABCD Pattern

Final Thoughts

The results that one gets using the Martingale strategy are generally small wins but with infrequent and huge losses. Though there is a limit to how long one can keep doubling one’s wagers without going bankrupt, the strategy crumbles if one runs into a losing streak. The thing with Martingale is that it leads to an exponential rise in the numbers quickly. That is why doubling up every bet can become quite unmanageable.

In such instances, increasing the trade size continuously is untenable. Sooner, rather than later, you will be out of the market with huge losses. If we were to evaluate a group of traders that used the Martingale strategy alone for a long enough time, we could invariably expect most of them to make a small profit by avoiding getting into a long sequence of successive losses. On the other hand, the unfortunate ones who could not avoid the losing streak would have suffered a devastating loss.

Though the results of the Martingale strategy may appear satisfying, the strategy itself is quite inconsistent and cannot be used regularly. Many traders feel that the strategy offers more risk than reward and should only be used with a great deal of caution.

Nevertheless, it can be used as a tool to gain insight into the market. If you're looking to experiment with this approach, the easiest way is to begin in a trading environment that doesn't have a lot of risks associated. This strategy really demands one to have deep pockets.

One shouldn't just be stuck with a single strategy and be familiar with and utilize multiple strategies. The more strategies one knows, the easier it is to manage the variables and control the outcomes even when the market behaves in an apparently erratic manner.