Forex Money Management Martingale – An opportunity or a threat

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Does the Martingale Binary Option Strategy really work?

Does the Martingale Binary Option Strategy really work?

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Last Updated: Aug 29, 2020 @ 10:55 am

As the interest to trade binary options grows among traders worldwide, so as they are looking to explore every minute strategy that seems feasible and profitable. One of these strategies is the Martingale system.

Recently, i have seen quite a number of traders using the Martingale strategy as one of their primary ways of predicting the market movement.

The aim of this article is to point out (with reasons of course) whether the Martingale system of trading actually works.

Brief History of the Martingale strategy and How it works

A Martingale is one of the betting strategies that was developed and popular in the 18th Century in the francophone country, France. It was widely used among bettors for the head and tail coin game in the country. Since the coin has a 50% probability of turning up either head or tail in a single toss, this betting system suited the game.

This strategy had the gambler double his bet after every loss so that any one win would cover up all the previous losses plus a profit that is the same as the original betting size or amount.

Apart form the head and tail coin game, this betting system has also been applied to all games that have a 50% chance of either winning or losing like the Roulette, Casinos, Blackjack and others.

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The Martingale Strategy as regards to Binary Options Trading

This strategy is widely used by binary traders who use the “Call and Put” type of trading. These types of trading involve predicting whether the current price of an asset will either increase or decease in value after the expiry time. Therefore the Martingale can be safely applied because there’s a 50% chance of getting either a “call or put”.

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Here, the trader doubles his investment amount each time he/she loses. For instance, If I went for a “Call” on Eur/Usd and staked $10 on it and unfortunately lost the trade after expiry, i would stake $20 on the next asset. Another loss means that i would have to invest $60 on the next one and so on.

This is done in order to recover past losses and gain money equivalent to the original investment amount.

Take a look at the table below and see an instance of how this strategy works:

Trade # Trade Amount Trade Losses Next Investment Amount
1 $10 $10 $20
2 $20 $20 $60
3 $60 $60 $180
4 $180 $180 $540
5 $540 $540 $1,620
6 $1,620 $1,620 $4,860
7 $4,860 $4,860 $14,580
8 $14,580 $14,580 $43,740
9 $43,740 $43,740 $131,220
10 $131,220 $131,220 $393,660

The table clearly explains what you should expect from practicing the Martingale Strategy.

It is based on assumption and not a real data.

The table shows a case of an unfortunate trader who has experienced 10 losing streaks without a single win.

If he must recover his losses, then he must stake twice the value of the previous total losses (next Investment amount).

As you can see from the table, it can be pretty dangerous to apply this strategy since its just a gambling strategy. You can quickly get bankrupt if you don’t have enough funds to practice Martingale.

Assuming you trade different assets like stocks, indices and currencies all moving in different directions, you can’t expect to achieve a good result when you apply this strategy. There’s a high chance of accumulating big losses and this can wipe out your entire account unless of course, you have unlimited funds.

Another important factor that plays a role in Martingale is the trader’s emotion. Most traders don’t have the nerves to hold on and wait for the next profitable trade. They’ll be like, “Ah! Will these series of losses ever stop?” Once, you trade by emotion, then you can easily give up even when you’ve accumulated a series of losses.

Martingale trading system is only meant for traders with deep wallets and enough emotional balance to withstand any type of losses experienced. Unfortunately, many traders either do not have big wallets or are affected by emotions and therefore we advice that Martingale should not be used to trade Binary Options.

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Some often choose this strategy believing that it’s an effective money management technique. It is in no way a money management system because you will have to risk even up to 80% of your money to see that you recover your past losses.

An effective money management system in binary options entails not staking more than 5% of your capital on any single trade.

Even if you want use Martingale strategy, you should only do so as your last resort after your sound technical and fundamental analysis have failed you (although not likely).

The Anti-Martingale Strategy

This is also known as the reverse Martingale. It is a betting style where the trader increases the investment amount after wins while reducing them after a loss. The idea is to help the trader benefit more by winning trades and minimizing losses.

I do not recommend using either the Martingale or its Reverse for trading because trading depends on your level of financial knowledge and ability to predict the direction of the market correctly based on either your fundamental or technical analysis.

Besides, a good trader is supposed to develop a strategy that works for him in 85% of cases and therefore has no need to gamble with his precious funds.

Your Comments and Questions are always welcome. You can tell us your own view about the Martingale strategy.

The use of martingale strategy in Forex

At the mere mention of the martingale strategy professional traders are contemptuous frown and try to change the subject. In expert circles such strategies are not, since they are associated with a high-risk trade that does not require any knowledge and skills. However, if thoughtlessly use the tools, it is possible to lose the Deposit anyway. So below I will try to prove that with the right approach, the individual elements of the martingale in conjunction with the logic of risk management are able to make a profit.

How to use the martingale strategy in Forex for getting profit with minimal risk

The martingale roulette strategy is based on doubling the bet in case of losing and was originally used in casinos. In other words, if the bet is $ 1 has not played, we put $ 2, then in case of loss — of 4, 16, etc. This strategy advise to beginners in binary options where the task is to guess the price will rise or fall. And despite the seeming simplicity of the strategy based on the theory of probability event occurs in 50% of cases), losing the deposit is very simple — there is no guarantee that the same opposite event will not hit multiple times in a row (for example, if the rate of Call in a row will play Put).

How to use the martingale strategy in Forex. Suppose that the price goes up and at some point we assume that the market is being overbought, and therefore need to sell. Sell with lot size of 0.1.

However, the price goes up. We do not close previous trade and open another and again on sale, but already with a lot size of 0.2.

Our task is to wait for the price still will unfold, but so far what we lose. And if the price continues to go up, we again open a short position with lot size of 0.4. On the one hand, it may seem logical to open a long position if the price goes up, but where is the guarantee that it will not unfold? Because we hard going at a loss in anticipation of a price reversal, as there will come a time when the price still will unfold, bringing us the income or return.

This strategy can lead to the illusion that all loss-making trades sooner or later will be closed, but it is a gross error. First, there is the risk of falling into long-term uptrend, which will destroy the entire deposit. Second, even when the price reverses there is no guarantee that it will go down enough to cover the entire loss (i.e. down to the point of opening the penultimate position). Because in this form the martingale strategy in Forex is doomed to failure.

Minimization of risks in Martingale

Before you focus on the elements of the strategy of the martingale, I will warn that the martingale will not bring profits. You need a known profitable strategy that can be used as individual elements. You decide what to choose, but let’s assume that you already have the high leverage. A few basic rules:

  • trading is done only with setting stops that limit a big loss;
  • check the amount of negative trades in the history of the chosen strategy, consecutive. It is important to find not the maximum, and the average value of this parameter. For example, if we are talking about the M5, the testing time is 1-2 months for D1 — testing 1-2 years.

The strategies can be tested by utilities; – there are plenty of them on the Internet. After the number of consecutive negative trades of the strategy tare calculated in the history, the so-called “knee” is introduced to the strategy— orders with a larger lot, which correspond to this number. For example, if your strategy has 3 unprofitable operations, the number of “knees” will also be equal to 3.

A practical example. Assume that the stop is 10 points, the Take Profit order of 20 points, the average amount of unprofitable operations — 3. The price starts to move up, you decide to open a short position 0.1 of the lot.

The price continued to go up and snagged the stop loss, the loss from operations amounted to 10 points. The price continues to rise, you get the sell signal (that is, you assume that the price is about to reverse back down). And you open a short position, but with a larger lot. And here’s the caveat: it is considered that the lot should be doubled (so provides martingale in Forex), but it’s not. You can increase the lot of at least 10%, at least 3 times. We will increase it only by 50%.

And again we get a loss, because the price is not around and the position was closed by stop-loss. The loss amounted to 10 points again, but on a lot of 0.15. We do not despair and wait for the sell signal. And so it appears. Put a request up for sale again with an increase in the lot on 50%.

And then the third time, fortune smiles upon us and the set take-profit of 20 points works.

Suppose that we have all worked with a lot of 0.1 that it would turn out in the end? In the first position we would have got a loss of $ 10, the second similarly, the third would have received a profit of $ 20, has worked to zero. In our case, we have two positions lost $ 25, and the third received 40, net profit — $ 15.

But what would happen if the third time you lose the position? Remember, above we started from a conditional number “3 losing trades in a row?” This means that we can increase the lot three times. And if the 4th trade after the third will once again be unprofitable — we are facing abnormal market situation and the urgent need to limit the risks. If we continue mindlessly to increase the lot in a precarious situation, there is a risk of losing the Deposit. Because in this case, it makes sense to go back to the lot of 0.1 or 0.15 as long as the strategy will not be back to normal.

One more rule: don’t attach yourself to buying or selling. For example, the price goes up, closes our short position on the foot, and then a signal appears at the confident continuation of the upward trend. So why not use it? Open a long position with lot size of 0.15. And if suddenly the price goes down (false alarm), open a short position with lot size of 0.2.

Strictly adhere to the rules of risk management – the largest lot shall be not more than 10% of the deposit!

This strategy also works well in conjunction with the trading advisors. The main entry point (the first) is opened manually, the trading Advisor will automatically increase the lot size and automatically open additional trades.

To sum up. Not necessary to be skeptical to what at first glance may seem like a losing idea or even a fraud. Remember that on pyramid schemes (HYIPs) smart traders also make money, though these projects are considered to be to some extent fraudulent. So why not get it from things like the best or go to trade wisely? Martingale in Forex sometimes can bring though not great, but the profit, by the way, as in binary options trading.

The Martingale approach and averaging down

Nothing creates a split camp more in gambling circles than the Martingale system. One side will say it is amongst the oldest and simplest ways to ensure a profit, whilst the other will mutter darkly about it being one of the most expensive ways to learn a lesson.

Developed in France in the 18th Century, the Martingale system works on a fifty/fifty premise such as blackjack, or a heads or tails format. The idea is that if you keep doubling your bet after each loss then eventually you will win back all your money.

The Martingale was introduced by the French mathematician Paul Pierre Levy and much of the study in the area was carried out by American mathematician Joseph Leo Doob who sought to disprove the possibility of a 100% profitable betting strategy.

Most experts use the roulette table as an example for how the system works. If a gambler bets £10 on red and loses then he must double his bet to £20 on red. If he loses again he doubles it once more to £40 and so on. When he eventually wins he will not only return his losses, but will guarantee a win of the initial bet.

According to the memoirs of Venetian author and adventurer Giacomo Girolamo “Casanova” de Seingalt, this simple betting progression was in vogue at the original Ridotto Casino as early as 1754. Casanova wrote of doubling the size of his wager after every loss until his bet eventually won. He added, though, that “bad luck” meant he soon “left without a sequin.”

Martingale in stock market trading

In stock markets, the Martingale strategy is implemented when a trader keeps doubling his position size till he makes a winning trade.

There are variations on this, where the trader increases his position each time he loses but not necessarily by doubling it. Instead our trader increases his position by a smaller amount, adding say 30% or 50%, rather than 100%. This is sometimes called smooth Martingale.

The Martingale system, however, has many practical drawbacks in this environment.

As it has a statistically computable outcome, the Martingale system can under certain conditions create incremental profit. Yet, the principle of it can only work if the pattern remains uninterrupted. In reality this requires an extremely large, if not infinite, bankroll.

For this simple reason most professional traders will avoid the method as the majority of people have to work within the boundary of their limited bank balance.

In addition, as markets are affected by so many external factors, from national disasters to regulatory announcements, it is unlikely that the pattern can continue without being knocked sideways by a market curve ball.

The risk-reward ratio is another disadvantage. You can’t predict the number of successive losing trades that will take place, so the risk will keep increasing with each trade. Yet the possible reward is limited to the position size of the first trade.

There are also costs involved with every trade such as brokerage and in certain markets there are taxes on each transaction too. All shares will not get the best offer rates so bids will need to be increased. Similarly, you may not be able to sell all your shares at the best bid rate and you may have to decrease your offer.

Gamblers’ fallacy and other behavioural bias at play

Many experts claim that Martingale as a strategy leans into gamblers’ fallacy and the notion that to catch the anticipated good luck they must keep on gambling.

It is based on the belief that the chances of something happening with a fixed probability become higher or lower as the process is repeated, yet this is a misconception as, more often than not, previous outcomes have no bearing on future outcomes.

Investors can fall prey to gambler’s fallacy in two ways. The first will be to hold on to stock that is falling in the belief that it can’t keep on falling. The second risk is liquidating too early as it seems unlikely that the stock can keep rising.

As psychologists Amos Tversky and Daniel Kahneman discovered, most of us like to avoid losses. Their research found that the average person is willing to risk a potential loss only if he or she stands to gain at least double that amount.

The sunk-cost fallacy

Another study by psychology professor Harold Miller from Brigham Young University found that behavioural-driven financial fallacies can go hand-in-hand. He found that people who demonstrate loss aversion are more likely to fall victim to the sunk-cost fallacy, and vice versa.

He said: “The sunk-cost fallacy is behaving as if more investment alters your odds. In a way, you are also motivated by an aversion to loss, but you keeping investing more, believing the more you put in, the more it will pay off.”

The principle behind it is that the same people who avoid loss are more likely to double down on risk irrationally.

Averaging down

Investors have three options when stock starts to fall. They can:

  • sell and take a loss
  • hold and hope
  • average down (double down)

With double down the idea is that you throw more money after bad in the hope that the stock will perform well.

This Martingale strategy can be implemented through a series of closed positions that have gone against you, or by averaging within an open position. In the first case there is a real loss and the next time the volume is doubled. In the second case, there is an unrealised loss and a volume is added to the open position.

This ‘doubling down’ is the key to the Martingale System and according to trader and strategist Steve Connell, Martingale in a “nut shell” is a cost-averaging strategy.

Averaging down is the widespread practice of buying more stock of something you have already invested as the price falls. This then lowers your average price and that makes it easier to break even or to turn a profit. However, it also makes it easier to lose more money as you’ve built a larger concentration of shares.

It can be a dangerous strategy as the asset has already shown weakness, rather than strength. Some feel adding more cash to the pot is only compounding the problem as it can only work if the stock price rises again.

Historic oil price drop
Don’t miss your trading opportunities

Connell said: “The idea is that you just go on doubling your trade size until eventually fate throws you up one single winning trade. At that point, due to the doubling effect, you can exit with a profit. The act of ‘averaging down’ means you double your trade size. But you also reduce the relative amount required to re-coup the losses.”

They key is to hold on to the stock for as long as it takes to recover, but If it keeps on falling it could be the fast route to bankruptcy.

Connell added: “Averaging down is a strategy of avoiding losses rather than seeking profits. Martingale doesn’t increase your odds of winning. It just delays losses – for a long time if you’re lucky.”

If you practice short selling, the same risks and same logic appear if you average up and throw more money into a position if the price goes up when you hoped it would go down. Again, you can do this for a series of closed trades or within an open traded with an unrealised loss.

The reverse Martingale

A more logical method for traders, especially Forex traders, is to use an anti-Martingale system. This is something that is seen by many to be a more effective way to maximise opportunities as it hangs on to winning trades, and drops losers.

As a strategy it requires discipline as psychologically it can be harder to add on risk when you are already in profit.

However with the reverse-Martingale, the averaging up rather than down means your profits can be turned very quickly into loses should the market turn against you.

Investors who average up can limit the average price that they pay for stocks by making smaller and smaller purchases as the price gets higher. This is known as pyramiding and was something that Warren Buffet did with Berkshire Hathaway.

When could the Martingale system be profitable?

Some more experienced traders claim that a ‘smarter’ version of the Martingale system could be used when trading binary options. To do this a maximum limit should be set and traders need to keep in mind that even when you are winning you could also lose at a certain point. It is also important to only to go ahead only when you have something you can afford to lose.

Another benefit is that you don’t need to predict the market direction to use it as it has a well-defined set of trading rules.

Martingale trading systems are also popular in Forex automated trading, because, unlike stocks, currencies rarely drop to zero. Although companies easily can go bankrupt, countries cannot.

The forex carry trade is a type of strategy in which traders sell currencies of countries with relatively low interest rates, and use the proceeds to buy currencies of countries that yield higher interest rates.

A note of caution is that these currency pairs with carry opportunities often follow strong trends so can be victims of unexpected changes in the interest rate cycle.

Experts also go to lengths to point out that you need to be disciplined enough to bank your gains so that they don’t snowball for too long. In Forex there are flexible tools to control martingale trading such as the ‘stop-loss and take-profit’ orders.

Forex trader Andriy Moraru, said: “The major problem for martingale systems in gambling is that every next result is completely independent of the previous results, so the streak of any number of losses is totally possible. In Forex the probabilities are not linear, so the streaks can have some inner logic dependent on markets.

“It makes martingale trading system less predictable and potentially profitable if optimised to the market conditions. But well optimised and modified martingale systems, in my opinion, can’t be called martingale and can’t be discussed as the one.”

Common errors made by losing traders

This ‘double up to catch up’ method is one of the common errors made by losing traders. There is a school of thought that if you are averaging down it is because a mistake was already made in stock selection and buying more stock is throwing good money after bad.

It might, therefore, make more sense to move on and invest in something else. Yet, psychologists say it is an instinctive reaction to take on a greater risk if you are on a losing streak, believing that eventually you will strike gold.

Robert Williams, a professor of health sciences and gambling studies at the University of Lethbridge in Alberta calls it the “near miss” effect. He says it is like when people play the lottery and get half the numbers right and think they were “so close” so promptly re-enter. “So while they might believe that they just missed the target, the difference in probability is actually in the hundreds of millions.”

This is why it is advisable before averaging down on any investment that the investor has a plan, rather than throwing money ad hoc into a company with a falling share price and getting carried away.

Carry out due diligence on the companies you wish to average down on so that quick action can be taken if needed to cap a loss. Some analysts even say that you should average down only when nothing about a company has changed except its share price.

Before adding to a losing position investors should ask themselves this question: how much faith do I have in my initial research or do I just need to acknowledge I made a mistake and switch to the next opportunity?

Professional traders need to plan and adapt endlessly. Thinking ahead is the key to this as is treating every trade individually.

Doubling down using a Martingale strategy requires patience, confidence in the stock and knowledge that markets do not always move in your favour. The same as in roulette, just because the ball landed on red the previous ten times, doesn’t mean that the next one will be black.

Martingale, in all its forms, comes with a warning. Be careful. Professionals apply this approach inside predefined trading systems. But even if you are an experienced trader, make sure you have good risk management strategy in place. Martingale is an easy way to lose a lot, fast.

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