The Martingale Trading Strategy is a strategy that involves doubling the size of your position anytime you have a loss until you have a winning trade to recoup your losses. This strategy carries a lot of risk however because it requires a large amount of capital to maintain the increased trade sizes. There is a better version of this strategy called the Anti-Martingale Strategy but let’s look at the original version before we get to that.
Who Created It
A French Mathematician documented the Martingale Strategy in the 18th century named Paul Pierre Levy. Instead of relying on luck, the system was based on probabilities. Levy believed that a gambler could still win money even when they didn’t have an advantage against the house by “doubling down”.
How It Works
The idea behind the Martingale Strategy goes like this, if you were to place a $100 bet and you lose then you would double your bet to $200 and as you keep you losing you would double it again risking $400 and then to $800 and so on until recoup the original $100.
This system can be applied to day trading as well. Let’s say for your first trade you start with $5,000 and a profit target of 5% and a stop loss of 5%. So using the Martingale Strategy in this scenario means if you were to have 5 straight losses in a row and the 6th trade hitting your 5% profit target it would look like the example outlined below.
- Trade $5000 = Loss $250
- Trade $10,000 = Loss $500
- Trade $20,000 = Loss $1000
- Trade $40,000 = Loss $2000
- Trade $80,000 = Loss $4,000
- Trade $160,000 = Profit $8,000
Total Profit = $250
This is the idea behind the strategy to keep doubling your trade until you get your original profit target from your first trade.
Drawbacks
There are some significant drawbacks to the Martingale Strategy and number one is capital. If you were to start with $1 and double it each time, it would only take you 20 iterations to reach over $1,000,000. If you do not have enough capital, you should not attempt to use this strategy.
You have to be able to handle risking large amounts of money to recoup the small profit from your original trade. All it takes is one time for you to have too many series of losses in a row and then you will end up with a significantly large loss.
The odds of having a high running loss streak depend on the strategy you are using. Trading is not 50/50 like flipping a coin is but if you were to take a coin that has a 50/50 probability and flip it 10 times, there is a 1 in 1024 chance of it hitting heads all 10 times. In trading, you definitely can run the risk of having 10+ losing trades in a row if your strategy is not tested properly.
Read Simple Guide To Using Proper Risk Management When Trading to understand more about how to use risk management.
Benefits
Where the Martingale Strategy could work is if you are very confident in your trading strategy. You have tested it and you know there is a very low probability of a long losing streak then this strategy could work but it is considered a high-risk strategy.
For example, if you know that the strategy you are using has a low probability of having more than 5 losses in a row, you could weigh the risk vs reward and attempt using it if you are comfortable with the risk. However you need to have a limit before even attempting the Martingale Strategy and if 5 losses are it, then you need to stop there and accept the loss before it gets too big.
The Anti-Martingale Strategy (A Better Alternative)
A more conservative approach to the Martingale Strategy is the Anti-Martingale Strategy. The key components of this strategy are to halve your bets each time you have a loss and to double your bet each time you have a win. This can be more risk-averse than the original version of the Martingale Strategy.
The idea is that winning and losing happen in streaks and if you encounter a losing streak, you will be halving your bet each time thereby reducing your risk. When you are winning, you are doubling your bets to take advantage of the premise of a winning streak.
Using this strategy in day trading can be advantageous because everyone has had those times when the market is trending and moving in a predictable pattern and winning trades come easily but then you end up giving up those losses when the market inevitably changes to a less predictable state like a choppy market.
To learn more about identifying market conditions read How To Correctly Identifying Market Conditions When Day Trading.
Conclusion
The Martingale Strategy has inherent risk as explained above, so a far better option would be to use the Anti-Martingale Strategy when day trading to minimize the risk of having too many losing trades and not enough capital to sustain the losses.
