Martingale systems were known as early as in the 18th century. They were based on the simple observation that is common in the theory of probability: under the certain circumstances one can count upon the probability of the occurrence of the certain event. The usual explanation used to be a coin. It may fall heads or tails up. In fact, the probability of falling one side up is 50% and this principle works quite well in the long-term. It means that by spinning a coin up ten times one can expect tails to fall six or seven times making 60 or 70 per cent. However, by repeating the procedure 100 or even 1000 times the probability will maximally come to 50 / 50.
So, what is a principle of the Martingale strategy application on Forex? Here we will give some basic recommendations made by many traders who operate at the international currency market.
1. Before a trading position is opened you should use any indicator you like to define the current market trend.
2. By opening the trading position you should establish take-profit and stop-loss which will be equally located from the market entry point.
3. After the price reaches its extreme value you should react according to the Martingale principle:
o If a transaction closes in the black you can open the next trading position with the initial lot along the trend;
o If a transaction closes in the red, you should increase the lot volume twice and open it in the direction of price movement.
The last moment requires additional explanation. For example, the trend is rising, the buying position is opened assuming the further development of the current trend and the stop-loss has worked out. So, the following transaction with increased volume should be opened for sale though the trend can continue without turns.
Thus, in theory Martingale strategy on Forex works well and shows that one can earn substantial money by doubling up the lot. In practice, permanent necessity of such a large deposit can result in the total unviability of this method. Besides, according to the statistical data we can single out the evident trend that Martingale strategy works well only in the long-term.
We can see a certain paradox here as the advantages of this strategy are designed for the short-term trading, but have no stable results. However, under the certain conditions the pure mathematical approach which the given strategy is based on proves its worth.
Martingale strategy shows good results on the stock markets. Here it is based on the principle of averaging of the results. For example, a client buys a share at 100 USD expecting its further growth. If the price grows by 10 USD he sells it and gains the profit of 10 USD. If the price decreases by 10 USD up to 90 USD he should buy one more share at new price. Thus, the averaged price of two shares will make up:
(100+90) / 2=95 USD
If the price grows by 5 USD soon the player will close his position and earn the same 10 USD. However the price can continue falling down that means that at the level of 85 USD it is necessary to buy two more shares in order to average the price up to 90 USD and so on.
(100+90+85+85) / 4 = 90 USD
It is not the only type of averaging strategy. There are also other strategies applied at the market. However the general principle of all the types is increasing of the quantity of the positions in case the price moves against the expected direction.
Depravity of the Martingale strategy lies in the principle of opening the increased number of positions against the trend in the course of its growth. Moreover the probability of the trend continuation is more than the probability of its turn and correction.
However, the trader can also use completely new approach. Its idea is to continue increasing the profitable position along with the trend movement and in case of the trend turn to close all the active positions. In practice, this solution is rather effective however it has certain disadvantages.
All the experienced Forex traders who use different strategies based upon the Martingale principle underline that it is vitally important to obtain thorough knowledge about Forex and to avoid any emotions in order to have good results. Thus, the given strategy loses its unobvious “advantage” when new comers are told just to use doubling of the transaction until they get their profit without obtaining any understanding of the Forex core principles.
In practice, experts draw our attention that this strategy is effective only in big time frames and based on technical or fundamental analysis. In case the fundamental analysis is applied you should have special Forex economic calendar at hand. Technical analysis is used for defining the trend direction and helps avoid dangerous trading under sideways trends and increase the probability of opening the very first trading position correctly.
If we analyze the Martingale principle and its practical value in different trading strategies attentively we will easily see the following misapprehension of facts. It is not the idea itself that is false. False is the opinion of many traders who consider that they don’t need to apply additional security stop-losses while using different trading schemes.
Speak plainly, you should not forget about simple principles of capital management. You should correctly calculate the risks that will be considered in the series of unfortunate transactions and exclude M5 from you work. By making the safety bag the trader can easily apply strategies based on the Martingale principle without being afraid of negative consequences.