So, what is the Martingale Strategy? Origin and Development
Table of content
- So, what is the Martingale Strategy? Origin and Development
- The Emergence of Martingale Strategies in 18th-century France
- Introduction of Martingale in Probability Theory
- Martingale in Modern Trading
- Risks and Drawbacks of the Martingale Strategy in Trading
- Mitigating Risks and Improving Profits
- How to use the Martingale Strategy in an actual trade
- Taking precautions using the strategy
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The Emergence of Martingale Strategies in 18th-century France
Martingale originally referred to a class of betting strategies popular in 18th-century France. The most straightforward of these strategies was used in a game where the gambler would win their stake if a coin landed on heads and lose it if it landed on tails. The gambler would double their bet after every loss, ensuring that the first win would recover all previous losses while also yielding a profit equal to the initial stake. As the gambler’s wealth and available time approach infinity, their probability of eventually flipping heads nears 100%, seemingly guaranteeing success with the martingale betting strategy. However, due to finite bankrolls, the exponential growth of the bets ultimately leads to the gambler’s bankruptcy. Stopped Brownian motion, a martingale process, can be employed to model the trajectory of such games.
Introduction of Martingale in Probability Theory
In 1934, Paul Lévy introduced the concept of martingale in probability theory, though he didn’t name it. The term “martingale” was later coined by Ville in 1939, who also expanded the definition to include continuous martingales. Much of the foundational work on the theory was carried out by Joseph Leo Doob and others. The development of this theory was partly motivated by the aim to demonstrate the impossibility of successful betting strategies in games of chance.
In the current moment, the martingale strategy is still utilized, albeit in a modified form, particularly in trading. Traders have adapted this approach to manage their investments by adjusting their position sizes to account for market fluctuations. These modern adaptations of the martingale strategy are often employed on a monthly basis.
Now that we’ve covered the historical context and origin of the Martingale strategy, let’s dive into its application in trading.
Martingale in Modern Trading
The Martingale strategy, originally developed as a betting strategy, has since found its way into various trading systems. Like in betting, the strategy focuses on doubling the size of your investment after each losing trade, with the aim of recovering all previous losses and eventually turning a profit. The strategy was introduced by French mathematician Paul Pierre Levy, who posited that regardless of the number of losses, a single winning trade can turn the tables around.
Risks and Drawbacks of the Martingale Strategy in Trading
Of course, every strategy involves risks, and the Martingale strategy is no exception. One significant risk in using this strategy is the need for a substantial financial backup or supply of money in the account to handle the accumulation of losses before the eventual win. Remember that for every loss, one must double the investment in order to win back all losses and gain profit. Unfortunately, this strategy does not provide many gains and may cause your account to go bankrupt.
Mitigating Risks and Improving Profits
In spite of these drawbacks, there are ways to increase the chances of winning and gain good profits using this strategy. Traders can:
Set strict stop-loss orders to limit the size of losses.
Diversify investments to minimize the overall risk.
Employ risk management techniques to protect their account.
By combining the Martingale strategy with other trading tools and strategies, traders can increase their chances of success and reduce the potential for catastrophic losses.
Simply put, the Martingale Strategy is about doubling the size of your traded value every time you get a losing trade or bet. This strategy points out that you cannot lose all the time – or there is a limit to the number of times you can lose in a trade or bet. With every losing trade or bet, you double the size of your investment until you arrive at that winning trade which will cancel out all the losses and will give a profit or gain.
This was introduced by Paul Pierre Levy – a French mathematician and this strategy revolve around the principle that regardless of the number of losses, a single winning trade can turn the tables around.
Of course, every strategy involves risks and the Martingale strategy also has one which can be financially devastating without diligent preparation. The great risk in using this strategy is that one must have a good financial backup or supply of money in the account to handle the accumulation of losses before the win. Remember that for every loss, one must double the investment in order to win back all losses and gain profit. Unfortunately, this strategy does not provide many gains and may cause your account to go bankrupt. In spite of these drawbacks, however, there are certainly a few ways on how to increase the chances of winning and gain good profits using this strategy.
How to use the Martingale Strategy in an actual trade
The first thing to note when using Martingale Strategy for trading is to consider only the “true candles”. A true candle is a candlestick which contains a wide part and almost without a wick on both ends – this body of the candle is also called the “real body”.
For our example, let us use the stock AMAZON on eToro.
To apply the Martingale strategy on trading, you’ll have to consider all types of red candles as a loss – regardless of their pattern. The same goes with the green candle which is a win – regardless of the tails, opens, and closes.
Let’s say you have $10000 in your account and, you start to buy AMZN stocks for $5.
Using the Martingale calculator, you will be able to track how much you should spend on each losing trade and your chances of losing a trade.
Upon purchasing the stock, you spent $5 as your initial investment. At the next trade, you get a loss and with that, you double your investment to $10. And on the third trade, we see in the image that you made another loss which brings you to another double the amount – now giving you $20. Unfortunately, the fourth trade is also a loss which brings you a double in the previous trade which is $20 x 2 = $40. Soon after the fifth trade, you get a win which not only pays back the $40 investment but also a small amount of profit due to the huge increase in the price range.
As far as the basic application of the Martingale strategy is concerned, we can see in the example that the strategy is easy and uncomplicated. After every win, the trader can start over again with the strategy. This basic strategy can help you gain wins even though in small amounts. Despite the risks of losing, one is always ensured of a win at the end which cancels all incurred losses.
Although this strategy may seem reliable not only in the field of trading but also in gambling and betting, it actually has one major drawback. The major flaw of this strategy is that it is not effective for steep down trending stocks. And as we know, if you get a stock that is down-trending, you encounter a string of losses. Using this strategy over the long series of losses, you will also need to spend more as you double your investment on every loss. Unfortunately, there is a limit to what you have in your account. And you may face the time where you can’t double the price on your last losing trade.
So, the major requirement of this strategy is that it requires a good and solid amount of financial backup or money on your account. Unfortunately, not all have this kind of luxury. So, is there a way to make this strategy more useful and safer? There is!
Taking precautions using the strategy
There are actually a few tweaks that you can add to this strategy to make it more effective and to reduce the risks. They are as follows:
Consider only full-bodied candles
One thing that you can add to this strategy to lessen the risks is to focus only on the full-bodied candles. Full-bodied candles are better-preferred candle formations because they highlight the difference between the opens and closes in a trade. The good thing about using full-bodied candles is that you get to reduce the instances of doubling the amount on every loss. On the image, we can see that we’ve only doubled the investment twice before getting a winning trade. While you can focus only on the full-bodied of the losing trades, you can also consider the full-bodied candles for winning trades for higher potential gains.
Consider up-trending patterns
The next thing to do in order to reduce risks in using this strategy is to consider stocks that are on an up-trending pattern. Up-trending stocks are easy to identify as they are the stocks that are moving up or climbing up in the chart. The good thing about this type of stock pattern is that you know the stock is moving up, it may lose a few trades but there will be great chances for it to move up thus winning a trade.
Consider other indicators
You may also want to consider other indicators when using the Martingale strategy to increase the chances of gains and reduce risks. A few indicators that you can use are the Support and Resistance indicators to know your trading range – you can either start or stop at the Support or the Resistance. Support and Resistance indicators also provide you with good signs of when to buy and sell. You can also use other indicators such as MACD, RSI, and moving averages to pinpoint stages or levels where you can double your trades upon losses.
The Martingale strategy is indeed a great road to take provided you are equipped with enough ammunition as back up. With that being said, it may not be the best strategy to use if you are starting out with a small amount in your account. However, the strategy can indeed be modified to lessen the risks and increase the chances of getting that one single trade that wins all losses back.
So, while other traders do not advise using the Martingale strategy because of the risks involved, it actually depends on how it is used. Using the considerations mentioned in this article, you will be able to lessen those risks and you will be more confident in executing your decisions when trading.
Master this strategy on your Practice Demo Account Before you start trading on your Real portfolio is advised.
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