17 Oct 2019
Understanding the Martingale Forex Strategy
If you flip a coin and choose heads over and over again, there is a strong probability that you will eventually win at some point in time. The Martingale strategy is based on similar fundamentals. Introduced in the 18th century, the Martingale Strategy of investing is based on increasing position sizes, while lowering the size of the portfolio. Statistically, a trader cannot lose all the time. So, according to the strategy, if you keep on increasing your investment allocations (despite losses), there are chances that a single successful trade will eventually reverse all your losses. If it sounds too much like gambling to you, you are quite right. The system was originally developed as a betting style, based on the strategy of “doubling down,” by mathematician Paul Pierre Levy. It was commonly practised in the Las Vegas casinos, which is why casinos today have betting minimums and maximums and why there are two green markers on the roulette wheel, in addition to the odd and even bets. It is a highly risky strategy and is not too favoured by traders today. However, knowledge is key and therefore it’s useful to learn about the Martingale strategy.
Relevance in the Forex MarketPosition sizing is a tricky but vital aspect of trading. The Martingale strategy deals with this aspect. It is a negative progression system, which includes increasing your position size after a loss. More specifically, doubling the position size. Traders then try to trade an outcome, which has 50% probability of occurring. The strategy seems suited to someone with an infinite supply. With a large number of buy orders, a trader will eventually score a win at some time and in case they have doubled their position size after each loss, when they do win, they might not just recover all their losses but also get back the original investment.
Steps in the Trading SystemEvery trade has two potential outcomes, profit and loss, and both have equal probabilities of playing out. So, let’s name the outcomes A and B. Now, imagine you enter a trade for $10, hoping to get the A outcome but instead you end up with B. Note, that the risk-reward ratio is 1:1. Next, you trade $20, again hoping for outcome A, but get outcome B. Now, you have lost $30 in total. You continue doubling down till your desired outcome occurs. Eventually, the size of the winning trade will exceed the losses. If you had a huge amount of capital, the following steps could have yielded the results.
- Use the currency pair and timeframe
- Determine the basic position size
- Place a buy or sell order, with fixed stop-loss and take-profit levels
- When the stop-loss or take-profit get triggered, you either win or lose
- If you win, go back to step 3. If you lose, double your position and go back to step 3.
- With unlimited trading capital, you might just score a huge win eventually.