If someone came to you and said that there was a trading strategy where you were always guaranteed to make a profit, there is a very good chance that you wouldn’t believe them. However, such a strategy does exist. It’s known as the martingale – and you should avoid it at all costs.
The martingale isn’t unique to forex trading. In fact, you could just as easily use it in a casino – and people have being trying that for more than 200 years. The problem is that there is an extremely good chance that you will run out of money before you ever make that elusive profit.
Guest post by Mihai Milea of XTB UK
Here’s how the martingale works. Let’s suppose that you are betting on the flip of a coin and have a bankroll of $100. There is a 50/50 chance whether the coin will come up heads or tails. You bet $1 on heads, and you lose. Instead of just accepting your $1 loss, you double down to $2 on the next flip the coin. You lose again, and double down again to $4. On the third flip, you win and get your $4 bet back plus another $4. If you count it up, you lost $3 on the first two flips and won $4 on the third one – so you are up $1.
In principle, you can continue to do this forever, losing bet after bet that still making $1 profit when that win finally comes in. Of course, once you do win, you start off betting $1 again. The problem is that if you hit a large run of losses, you will end up losing your entire bankroll before you win. With your $100 bankroll, you only have to lose 8 times in a row to run out of cash.
There are quite a number of forex traders who use the martingale strategy – or something like it. When they start to lose, they increase the size of their position. In effect, they are following a doubling down strategy – although you may hear it referred to as averaging down. The idea is that by buying more at a lower price, they reduce the average price that they pay for their overall position – and will make profits when the market turns.
You might think that hitting a long losing streak when you do this would be incredibly unlucky. However, one of the key things that characterizes the forex market is trends. These can continue for weeks, months or even years – sometimes without any fundamental reason driving them. In other words, by the time the market does turn, you could well be wiped out.
Another reason that some forex traders think that the martingale strategy will work is that currencies aren’t like stocks – there’s very little chance that one of the six major currencies will go to zero, while a stock can do this if the company goes out of business. This means that a losing streak can’t continue forever. However, it can continue for long enough to bankrupt you – and that is all that you should care about.
Risk warning: “Forex and CFDs are high risk and losses can exceed your initial investment”.
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