Martingale in Forex Trading - Good strategy or hazard?
In this new article, we are going to have a look at the martingale system. What is martingale? Is it a viable money management strategy or pure hazard? Let's find out!
Martingale System Introduction
The martingale systems are widely used casino, sports betting, but the principles are also used by many traders in the financial markets.
And not only that. Martingale's principles are often part of the automated trading systems. How do you recognize a martingale trading system?
Usually by the fact that the system has an unbelievable balance curve.
The problem is that these systems are extremely risky. In this FX Experiment, we will examine the risk of these systems.
First, we need to clarify what Martingale is all about, the first part will be rather theoretical.
If you already know this system, you can jump straight to the second part where it is already being tested on historical data.
Let's imagine the classic casino roulette and color betting.
The result may be only that the ball ends in the black or red territory.
If the roulette works as it should be, the probability of a ball landing on a red number is the same as the probability the ball landing on the black number, 50%.
Suppose the player bets constantly on red $10.
If the ball actually falls on red in the first round, you get back your deposit and win an extra $10.
If the ball lands on a black number, then in the second round you need to deposit $20.
If you win this time, you will get back your bet of $20 and win another $20.
The winner will cover the first $10 bet and earn $10 extra. If the ball lands on the black number, the next round you will bet $40, and so on.
The principle is to double the deposit in the case of the bet is lost.
The player is expecting his or her color to fall sooner or later and make a profit of $10 regardless of the number of rounds.
If a player had unlimited capital and an unlimited number of rounds, then he would realize the endless risk-free profit.
The problem, however, is precisely the amount of capital that cannot be infinite. For illustration, the table below summarizes the Martingale principle:
The table assumes a capital of $10,000 and a $10 initial bet.
Even though we have a ten thousand times higher capital than the first bet size and therefore the expected winnings, we can lose it all fairly quickly.
As can be seen in the table, it is enough to have a streak of 9 bad colors and the player no longer has enough capital to make another bet.
There are reports that the same color fell even 30x or 40x in times in a row.
After the 30th round with an initial bet of $10, a player would have needed a capital of at least $10,737,418,230.
This is already the amount that few people have available. We encourage you to read this article written by a very famous Vegas trader on a similar subject.
The chart below shows a player who starts betting $10 on each round and has a capital of $1,000,000.
See how the bets are rapidly growing the same as the amount of capital declines.
After the unsuccessful 16th round, the player is already in minus.
The same principle is applied by traders to the financial markets.
Instead of bets on red and, they bet on the short or long side.
We will not deal with the reason why a trader enters long or short, the key is that when the market goes against the trader, the trader should open a new trade in the direction of the first trade, but the volume is twice as big.
Traders using the Martingale systems are hoping that markets do not move in one direction without any retracement.
The obvious difference from the Martingale trading system from the casino roulette is the choice of payout ratio - the Takeprofit distance and the price range at which the new position opens if the market goes against the trader
The Stoploss command in the Martingale system is usually completely missing, which is logical.
Instead, there are pre-prepared price levels for opening additional positions.
Just as in the case of roulette, where the underlying problem is a rising risk of bad bets, it is also true that what is seemingly impossible or unlikely will happen sooner or later and will have fatal consequences for the trading account.
Until then, the system will be consistently profitable. However, as soon as an unfavorable scenario is reached, the result is a margin call.
In the next chapter, we will program an automatic trading system, which will try to show how this system performs in some markets.
Be very careful while considering using any form of martingale strategy on your forex funded accounts.
Results of martingale in forex trading
The automated trading system works as follows:
- The first trade (long/short) is completely random.
- The system immediately sets a fixed Profit target, the Stoploss order is not set.
- If the position reaches a negative result, which equals the value of the profit target, the next position is open. Sequentially opened positions meet the following volume range: X, X, 2X, 4X, 8X, ...
- Profit targets of all positions are always set according to the Profit target of the last position.
- If Profit targets are filled, a new cycle starts from point 1.
Position sizes X, X, 2X, 4X, 8X are chosen so that the volume of the next position is equal to the sum of all previous positions. This ensures that each cycle ends with the same profit regardless of how many positions the system opens.
Testing was performed on the most popular and volatile instruments, namely the EURUSD and the DAX stock index. We performed tests for the period 1.1.2016 - 31.12.2016 on 99.9% tick data sample. The specific Take profit distance will be based on typical price movements and ranges. Since it is a random based system, the results will be different for the same parameters at each test, so we will do 3 tests for each instrument. We will present the test results for space reasons only in the form of the equity curve, from which you can see the profit and drawdown.
- Initial capital: $10,000
- Volume: 0,01 lot
- TP: 100 pips
This system achieved a 25% - 35% profit in all three test, which is a fairly decent result. However, three tests are not enough to fully see the level of the hidden risk. Let's do twenty cycles and write down and see in how many cases the system survived the whole trading period (1.1.2016 – 31.12.2016). The month when the system lost its whole equity is also noted.
The table shows that the success in three consecutive tests is not such an exceptional situation. 7 tests out of 20 tests lost its entire capital. From the table, it can be assumed that the probability of the system will bankrupt in 2016 is around 35%.
The average profit for the year is 34%.
Expected value (expectation) is: 0,65 * 3400 - 0,35 * 10,000 = -12%.
- Initial capital: $10,000
- Volume: 0,1 lot
- TP: 20 pips
The martingale system on Dax deleted the whole account in the first two tests in the first month, in the third test the Dax deleted the account in the second month.
It has been clearly shown that this system is capable of generating stable and relatively long-term gains, but they are redeemed at considerable risk.
This risk is hidden from historical results, so these systems are presented as holy grails, but they are also used by regular traders who are not aware of the risk associated with this technique and believe that the market "can not rise/fall indefinitely without correction".
This is undoubtedly true, but just as in roulette and in markets, there are extraordinary situations that few people count on.
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