Martingale system is a popular betting and trading system, which is commonly used in bets with equal or close to equal chances (red-black, odd-even, heads-tails etc.) According to martingale system gambler (trader) should double his bet after every loss and return the bet to initial amount with every winning bet. E.g. gamblers bets $10 on red, if he wins he bets $10 again, if he loses he bets $20 on red, if he loses again he bets $40 etc. If the gambler is has an infinite amount of money he will be always winning, because his next bet will not only return his losses, but will guarantee a win of the initial bet ($10 in the example). Martingale system was very popular in 18th century, but it still remains popular, despite its obvious and very important disadvantage.
Why all martingale systems fail? Because in reality gamblers and traders don’t possess infinite funds. A losing streak of 10 rounds will require a bet of 1,024 initial bets (e.g. $10,240 if your initial bet was $10) to recover from losses, 20 rounds long losing streak will require 1,048,576 initial bets and so on. Your next bet after a losing round should be B × (2 in a power of N), where B is the initial bet, N is the number of round. Another problem is that the chances are usually not equal for gamblers and traders — martingale system can’t be profitable with a chance to win less than 0.5. In roulette red or black has only 18/37 chance to win (because of zero), in Forex trading there is a broker’s spread, which shifts the chances against the trader.
Martingale trading systems are very popular in Forex automated trading, because it’s quite easy to create an expert advisor that would trade using martingale; also the system looks very interesting and profitable to many Forex newbies. Let’s look at the example of the martingale Forex trading. A trader starts his betting with 0.1 lot of EUR/USD on 1:100 leverage with 20 pips target and stop-loss. Every winning trade will bring him $20, first losing one will take $20, second losing — $40 etc. A standard account with $10,000 will be able to handle a longest losing streak of no more than 8 rounds (9th losing position will require $10,240 to recover). If he uses a classical martingale system he will be either always buying or always selling. Strong trends often happens on Forex, so it wouldn’t take long for the EUR/USD to go 162 (180 minus 18 for 2 pips spread on every positions) pips without significant corrections. As the option Forex trader might modify martingale system to use a random direction to enter every next position. This approach adds more randomness to the whole process.
In Forex there are flexible tools to control martingale trading — stop-loss and take-profit. One of the most obvious modifications is to use 22 pips stop-loss in the above example to equate the chances for losing and winning (unfortunately it will also increase the amount of money lost with every losing position, so, the win after 5 losses won’t fully recover them). Forex trader can go even farther and make stop-loss twice bigger than take-profit and quadrupling the position size after every loss (this approach looks like a good idea if the currency pair is volatile enough for the 20 pips movements (for example) in both directions are significantly more common than 40 pips movements); obviously it’s even more dangerous method.
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 optimized to the market conditions. But well optimized and modified martingale systems, in my opinion, can’t be called martingale and can’t be discussed as the one.
Despite what I think about this system, I would recommend every Forex trader (especially beginner) to try using martingale trading system on demo account and see the results and then try to modify it to be less dangerous and more stable.
