What Is the Martingale System?
The Martingale system is a system of investing in which the dollar value of investments continually increases after losses, or the position size increases with the lowering portfolio size. The Martingale system was introduced by French mathematician Paul Pierre Levy in the 18th century. The strategy is based on the premise that only one good bet or trade is needed to turn your fortunes around.
This technique can be contrasted with the anti-martingale system, which involves halving a bet each time there is a trade loss and doubling it each time there is a gain.
- The Martingale system is a methodology to amplify the chance of recovering from losing streaks.
- The Martingale strategy involves doubling up on losing bets and reducing winning bets by half.
- It essentially a strategy that promotes a loss-averse mentality that tries to improve the odds of breaking even, but also increases the chances of severe and quick losses.
- Forex trading is more well-suited to this type of strategy than for stocks trading or casino gambling.
Understanding the Martingale System
The Martingale System (also known as the Martingale Strategy) is a risk-seeking method of investing. The main idea behind the Martingale System is that statistically, you cannot lose all of the time, and thus you should increase the amount allocated in investments—even if they are declining in value—in anticipation of a future increase.
Martingale strategies rely on the theory of mean reversion. Without a plentiful supply of money to obtain positive results, you need to endure missed trades that can bankrupt an entire account. It's also important to note that the amount risked on the trade is far higher than the potential gain. Despite these drawbacks, there are ways to improve the Martingale Strategy that can boost your chances of succeeding.
The Martingale System is commonly compared to betting in a casino with the hopes of breaking even. When a gambler who uses this method experiences a loss, they immediately double the size of the next bet. By repeatedly doubling the bet when they lose, the gambler, in theory, will eventually even out with a win.
This assumes the gambler has an unlimited supply of money to bet or at least enough money to make it to the winning payoff. If that isn't the case, just a few successive losses under this system could lead to losing everything you came with.
Basic Example of the Martingale System
To understand the basics behind the strategy, let's look at a basic example. Suppose you have a coin and engage in a betting game of either heads or tails with a starting wager of $1. There is an equal probability that the coin will land on heads or tails, and each flip is independent. (The prior flip does not impact the outcome of the next flip.)
As long as you stick with the same call of either heads or tails, you would eventually, given an infinite amount of money, see the coin land on heads (or tails)—if that's your call—and thus recoup all of your losses, plus $1.
Drawbacks of the Martingale System
The Martingale System does not guarantee success for a variety of reasons. For example, most exchanges place a limit on trade size. At some point, you will not be able to keep doubling the size of your investment because you will reach that limit. If you haven't made back your money by that point, you won't be able to. There are other drawbacks as well.
- The amount you spend trading increases rapidly with each successive trade.
- Each trade comes with transaction costs, which increase the money you spend.
- The stock may stop trading or the company may go out of business.
- The risk is much higher than the reward since you spend higher amounts with each loss, but the profit will only be equal to the size of your initial investment.
- You can lose everything if you run out of money to keep investing.
Using a Martingale Strategy depends on mean reversion. And markets do often revert to their mean. But the timeline in which that happens is not reliable. Outside factors, such as changes in the broader economy or changes in the underlying asset, can impact the market and the value of your investment. Like any investment strategy, the Martingale System comes with risks and is not appropriate for every investor.
The Martingale System In Forex Markets
Martingale trading is a popular strategy in the forex markets. There are a number of reasons that make using Martingale a safer strategy in the currency market than when investing in other assets or when gambling.
Currencies, unlike stocks, rarely drop to zero. Although companies can easily go bankrupt, most countries only do so by choice. There will be times when a currency falls in value. However, even in cases of a sharp decline, the currency's value rarely reaches zero.
The FX market also allows traders to earn interest. This means forex investors following the Martingale Strategy can offset a portion of their losses with interest income. For example, a Martingale trader can use the strategy on currency pairs in the direction of positive carry. They would borrow using a low-interest-rate currency and buy a currency with a higher interest rate.
Is the Martingale System Profitable?
If you have the funds available to continue using the Martingale System until it works, it does allow you to make a profit. However, the risk to reward is not equal. You may have to invest, trade, or gamble large sums as you double your investment with each loss. Your eventual profit will be much lower.
Can You Use the Martingale System in Casinos?
The Martingale System works best in scenarios where there is an equal probability of two results occurring. You are betting that one result will happen eventually. It is possible to use this system when gambling. However, if the outcome you are betting on does not have the same probability of happening as all other outcomes, you are more likely to lose your bets than to recover your losses.
What Causes the Martingale Strategy to Fail?
Successfully using the Martingale Strategy depends on having enough funds to continue investing (or betting) until you recover your losses. If you have enough money, you can continue investing indefinitely until your investment pays off. If, however, you run out of money before that happens—or if you aren't investing in an asset that can offset some of your losses with interest income—you won't have the chance to recover what you've lost. The Martingale Strategy will fail if you don't have the capital to see it through until your investments experience a reversal.
The Bottom Line
The Martingale system is a methodology to amplify the chance of recovering from losing streaks that can be used in investing or gambling. It involves doubling up on losing bets and reducing winning bets by half. The strategy assumes that a single investment, or bet, cannot lose every time, and so if you continue increasing the same investment, eventually you will earn back your money plus a profit.
The Martingale System promotes a loss-averse mentality that tries to improve the odds of breaking even. However, it increases the chances of severe losses if the odds of the different outcomes happening are not equal or if you do not have the funds to continue making investments until you turn a profit. Using the Martingale Strategy is more well-suited to forex trading than trading stocks or gambling in a casino.