The beauty of the financial market is that traders are not limited to a fixed strategy. Instead, they are allowed even create their own strategies and use them to trade. As such, there are thousands of strategies out there that traders can use (4 we suggest to try).
The most common strategies are hedging, trend following, price action, and scalping among others.
In trend following, traders enter long or short trades when they believe that a trend is changing. In hedging, they open two correlated or uncorrelated securities with the hope that the trades will protect their trades.
However, there are also lesser-known or simply riskier strategies worth knowing about. In this article, we'll talk about the Martingale strategy, originally derived from the gambling's world.
What is Martingale Strategy?
The Martingale trading strategy is one of the opaque trading strategies that sophisticated traders use. The idea behind it started hundreds ago when a French mathematician proposed it. The mathematician was later awarded a major award for his work in the mathematical field of probability.
The idea is today applied in almost all casinos around the world.
The Martingale strategy is based on the principle of probability. It assumes that a price action of a security will often retrace.
For example, if you sell the EUR/USD pair that is trading at 1.1200 on Monday, the pair could go down and make your trade profitable. On the other hand, the pair could move up and leave you with a loss.
If the latter happens, you can take a loss. Therefore, in the Martingale trading strategy, after losing, you should double your trade and hope that you will win. If you lose again, you double the size of the trade and so on.
As such, if the fifth trade wins, it will mostly cover the previous losses and make you profitable.
As we will note below, the Martingale trading strategy is a relatively risky one since the probability of losing money is infinite. Furthermore, you are never sure that your trades will ultimately reverse.
As such, this strategy is mostly useful for traders with loads of money.
Related » Why Do Poker Players Become Successful Day Traders?
What is the anti-martingale system?
The anti-martingale strategy is the opposite of the martingale that we have explained above. Instead of adding the size of trades, it involves halving the bet each time when you make a loss.
After doing that, you double the size whenever you make a loss. Analysts believe that it is a safer option.
How Martingale Trading Strategy works
The strategy suggests that when this happens, a trader should then open another slightly larger trade on the same pair. This trade can turn a profit but if it makes a loss, the trader should exit it and open another larger trade.
The trader should then continue the same process three more times.
The idea is that if the fifth trade goes in the ‘right’ direction, the previous losses will be recouped.
In this example, the losses could be $10, $20, $30, $40, and then a profit of $120. The final profit for the trade would be $20.
When used well, the strategy can be profitable for traders. However, it comes with several caveats.
Related » How much money are you willing to lose?
Drawbacks of the Martingale strategy
There are several drawbacks when using the Martingale trading strategy. First, while the strategy can work in theoretical terms, the reality is that losses can mount. As you add new trades, there is a likelihood that they will not turn a profit. If this happens, since the trades are bigger, losses will be significantly high.
Further, the strategy has more transaction costs, especially when you are trading forex. In the US, these costs are not a big deal since more brokers like Robinhood and Schwab don’t charge a commission.
Related » Understanding spread in Forex
Another challenge is that it has a high risk-to-reward ratio. As such, while it can be a highly profitable, there is a likelihood that losses can be significantly high.
How to Use the Martingale Strategy in Forex
To be fair, the Martingale trading strategy is not very popular in the financial market. Indeed, only a few experienced professionals use it to trade. That’s because, as mentioned, it requires a lot of money because of the infinite probability of losses.
Here’s how you can use the Martingale strategy in forex.
First, you should have an original trading strategy. This could be hedging, algorithmic, and breakout strategy.
Second, you should then conduct your analysis and identify potential entry and exit positions. We recommend that you use small lot sizes and low leverage when using the Martingale strategy.
Third, you should open the trade and set your take profit and stop loss. Then, you should wait for the outcome of the trade. If you lose money, you should then double the size of the trade and wait. You should then continue this strategy until you make money.
How to avoid Common Mistakes
- The trader needs to define the maximum loss they are willing to take per trade. Using it without defining the maximum losses you are ready to take per trade can be dangerous.
- You should aim to stop the repetition after the fifth trade. If it does not work, you should move on to another pair or commodity.
- You should always use this strategy minimally (same as other YOLO trades). This is because the losses can add up. They can add up mostly when a trend of a currency pair continues for an extended period and you are betting for a reversal. As a result, you should use it during a ranging market.
- It is important that you take time to practice the strategy. A demo account at our Ppro8 will help you avoid the common mistakes when using it.
In addition, you should only use the strategy when you have a bigger account. Using it on a small account will make the funds in the account dry, which is not desirable.
In this article, we have looked at what the martingale strategy is and how it works. We have also identified the benefits of using the approach and the risks involved.
Also, we have explained what the anti-martingale strategy and why it is a safer option.
External Useful Resources
- For further Information Visit this Link InveStopedia