The Martingale forex strategy involves doubling the initial amount every time it becomes a losing trade. The idea is to try and cover all previous losses with a winning trade. However, if the positions keep on increasing and that winning trade does not come, this can lead to disaster. I have seen many martingale trading systems with huge drawdowns and blown accounts. A classic scenario for the strategy is to try and trade an outcome with a 50% probability of it occurring. The scenarios are also called zero expectation scenarios.
What is the Forex Martingale Strategy?
French mathematician Paul Pierre Levy first introduced the Martingale strategy. It gained popularity in the 18th century as a betting style. Gamblers doubled the bet each time after the loss until they found one winning trade that covered previous losses. The reason why it became popular was, it had a high success rate. However, if that winning trade does not come, it can end in disaster.
Martingale is one of the reasons why casinos now have minimums and maximums betting. The introduction of 0 and 00 in the roulette broke the Martingale system to get more possible scenarios from the game.
The Martingale relies on the principle of mean reversion. In financial markets, mean reversion is a phenomenon that assets price will eventually come to its average price.
Martingale is a cost-averaging strategy. It does this by “doubling exposure” on losing trades. This results in lowering of your average entry price. The idea is that you just go on doubling your trade size until eventually fate throws you up one single winning trade.
To make things clear, here’s an example:
Suppose a person has a total of $10 to bet on roulette. In his first attempt, he bets $1 on the red. But, the ball lands on the black, and he loses. He bets again with $2, but again he fails. He gambles for the third time with $4, and this time, he wins $8. His total profit is $1. How?
Let’s break it down how his net profit is $1.
His total spending amount is 1+2 + 4 = 7. He wins $8. So, 8 – 7 = $1. This way, a person recovers all his losses with a single winner.
As you double your initial amount, the Martingale is also known as doubling down.
American mathematician Joseph Leo Doob continued to work on the Martingale strategy. But, he denied that the strategy has a 100% success rate. I certainly feel that the martingale strategy is very risky and would do my best to avoid it.
Martingale in forex trading
Many of you will be wondering, what happens when this array of losses continues to happen?
This is where Martingale has an advantage in forex over any other financial markets. Unlike the stocks, currency pairs rarely do down to zero. Even in the case of market uncertainty, pairs don’t drop to zero.
Also, by doubling down, a trader lowers his/her average entry price.
The Forex market doesn’t naturally align itself with a straightforward win or lose outcome with a fixed sum. This is because the profit or loss of a Forex trade is a variable outcome. We can define price levels at which we take-profit or cut our loss. By doing so, we set our potential profit or loss as equal amounts.
Forex Martingale Example
Consider this scenario where you buy EUR/USD at 1.273. You only need to make a one winner to reach 1.274. If the price continues to go down and you add more lots, you lower your entry price. You may lose 100 pips if the price declines to 1.263. But, the price only needs to reach 1.274 for your profits. This would require substantial capital and a trader that is happy to take a lot of risk of losing all their money. Why? Because if the price did not reach the target, the account would be a bust! Again, this is why I would avoid martingale trading systems.
As mentioned above, a trader needs a significant deposited amount to get one winning trade for recovering his losses.
From the above example, if the EUR/USD drops back to 1.263, a trader loses 100 pips. This means if he has $5,000, he will go bankrupt before even reaching his initial buying rate of 1.273.
The forex market can continue to go in the same direction for an extended period, and this is where the Martingale strategy fails.
Risk to Reward Ratio
This is the main problem with martingale trading strategies. They have very poor risk to reward ratios where one bad trade can wipe out a long run of winners. I think it is a much better idea to simply cut losing trades short and let winners run as much as possible. I would even look to try and lock in good trades at breakeven point and perhaps use a trailing stop to maximise the potential of each move.
If you have a risk-reward ratio of 1:3, it means you’re risking $1 to potentially make $3. If you have a risk-reward ratio of 1:5, it means you’re risking $1 to potentially make $5. The issue with forex martingale trading systems are that the risk reward is usually always negative, that is if there is any stop loss being used at all. I have seen martingale strategies that do not even use a stop loss as they “hope” that the market will always turn into their favour.
However, all of these bad forex systems end up blowing the account and getting a margin call. Yes, you can make some profits for a while but it could even be the very first few trades that get caught in a sticky situation because of poor money management. I personally don’t think anything beats proper market analysis and sensible money management in the long term.
Forex Martingale Strategy Conclusion
Forex Martingale Strategies can be very dangerous. They work by increasing position sizes in order to try and recover from losses. This can cause large drawdowns, margin calls and blown accounts. Martingale money management is certainly to risky for my personal taste. I would much prefer to conduct detailed market analysis and use sensible money management with a favourable risk to reward ratio. I feel that martingale trading strategies are a way to hide poor market entry decisions. There are much more safe ways that you can trade without needing to worry about blowing your account with one bad trade.
Self-confessed Forex Geek spending my days researching and testing everything forex related. I have many years of experience in the forex industry having reviewed thousands of forex robots, brokers, strategies, courses and more. I share my knowledge with you for free to help you learn more about the crazy world of forex trading! Read more about me.