If there is a trading system or approach that tends to trigger a fierce conflict within the online traders community, this is surely the martingale negotiation method. This is perhaps due to the fact that the martingale approach to trading is based on odds and chance more than anything else. So what is this martingale trading method and should you use it? Read this article to form your own opinion.
What is the Martingale method?
The martingale is a probability theory for gambling that was developed by a French mathematician, Pierre Levy in the eighteenth century. Without getting too technical, from a trading-focused perspective, the Martingale method implies doubling the ante every time a loss is incurred. Taking the example of the launch of a coin with a probability of 50-50 that comes face or cross, in a martingale approach, every time there is a loss, the next bet is doubled, hoping to recover losses, as well as gaining a profit equal to the previous loss.
As can be seen in the basic definition of martingale, it can be a very profitable methodology, but very risky, to operate in the financial markets. The martingale approach is more popular with gaming, especially with roulette, where the chances of a red or black number are 50 – 50.
Therefore, to define the martingale from a trading approach, whether in Forex or other markets, we can say that it is nothing more than a cost averaging process, where exposure is increased (duplicated) in each losing operation.
Despite the risks posed by the martingale trading method, there are quite a few followers of this negotiating strategy. It is probably best to illustrate how to operate with the martingale using a simple example.
Remember that the exposure or size of the position is doubled (the bet is doubled) after each losing operation. For this example, suppose an operator has $100 in its trading account and initially risks $10 operating in the EUR/USD pair.
Operation amount Risky result profit/loss Balance
Buy $10 Take profit reached $10 $110 Buy $10 Stop loss reached- $10 $100
Sale $20 Stop loss reached- $20 $80
Buy $40 Take profit reached $40 $120
With respect to the table above we have to:
A purchase order was placed, risking $10. Assuming the take Profit was $10, the operation reached its profit-making goal, so the trader's capital rises to $110.
A purchase order was placed, risking $10. Here, the stop loss was reached, so the equity falls to $100.
A sales order was placed, but because the previous operation produced a losing position, the risk doubled to $20. This sales order resulted in a loss of $20 because the stop loss was reached, so equity is reduced to $80.
A purchase order was placed and the risk is doubled from $20 to $40. This time, the profit objective was reached, and it resulted in a profit of $40, which means that the capital rises from $80 to $120.
From the table above, it is now easier to understand that if the trader had had a series of losing operations, he would have lost all of his capital. What brings to the question, what happens if you use the Martingale trading strategy with a pair of currencies or an instrument where there is a clearly established trend? Of course, in this case, the results would be impressive. However, this approach is also not exempt from major risks. In essence, it is governed by how close it is to the stop loss of the entry point, or the amount that the trader is willing to risk/lose if the market moves against it.
Now let's look at the martingale strategy with another example. Suppose the EUR/USD pair is located at 1.3000.
Batch position price input current price profit/loss
Buy 1 1.3000 1.2995 -$5
Buy 2 1.2995 1.2990 -$10
Purchase 4 1.2990 1.2995 $20
In this example, notice how the position size doubled each time the price dropped 5 pips. While the total risky amount was $15, when the price returned to 1.2995, the profit of $20 managed to compensate for the loss and also gives the trader an extra benefit of $5.
But the table above is a better example of the concept we want to expose. Imagine What would have happened if the trend had changed and the EUR/USD suddenly began to fall ever lower. In such a case, the form of negotiation of the martingale would have ended with a substantial part of the trader's capital, but with its entire trading account.
The most important point of the previous example is the price movement itself. Ideally, if a trader had opened a buying operation in 1.3000 and the price had fallen to 1.2995, this would have resulted in a drawdown of $5 in fairness. For its part, the next 5-pips bearish movement would have produced a drawdown of $10 in fairness. However, thanks to the martingale approach, although the price was lower than in the first inning, the upward movement of 5 pips in the third transaction managed to turn the operation into a winning position while at the same time increased equity in $5 even though the price was 10 pips below the initial entry price. In other words, thanks to the martingale, the series of operations became a winning series. However, as we have already said, this does not always happen, especially when a strong and extensive movement against the trader is developed.
The martingale trading approach in theory works. However, for this to happen, operators need to have unlimited fairness, which is something that does not happen in the real world.
Using the martingale (doubling the volume of operations) together with market analysis
While the pure martingale trading system is something that is not advisable for accounts with a capital less than $5000, the focus of duplicating position sizes can be applied to increase gains within the structures of a pre-determined trading system.
But for this to happen, traders need to have a very high level of trust and experience operating in the markets. Discuss the following example: Here, we apply a simple strategy of price action scalping based on the trend line break method.
After a first open selling position near the minimum of the candle formed below the Fibonacci retracement of 38.2%, the price began a bullish movement against the operation.
After a 10 pips movement against the initial operation (Operation # 1), the second operation is opened with 2 batches (doubled with respect to the previous 1-lot operation). Being the objective of profit making for both operations the same, the results are very interesting.
If only the first operation is performed, without the use of the martingale, the total benefit of this position would have been $15.
If the martingale approach is used as explained above, an additional gain of $50 would have been obtained.
The risks, of course, for such a approach will be different, compared to a simple negotiating approach. In the preceding example, assuming that the stop loss for the sales operations was 1.02, the risk with the first operation would have been $27, while with the martingale approach of doubling the volume of subsequent operations, there would have been an additional risk of $34.
It is easy to understand that while the martingale trading methodology can potentially increase benefits, the risks are equally high and for many traders are simply unacceptable, as they can lead to strong losses and even to the loss of trading account easily. In order to succeed in using the martingale methodology, traders need to have a good risk management strategy together with a good preparation in technical analysis and familiarity with the trading systems they use.
We recommend IQOPTION and ETORO the best FOREX brokers and binary options
If you want more information about these brokers leave me a comment
Discuss if you have questions or questions or want to contribute something
0 Comments: