Martingale in Forex
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omid - Blog
omidIntroduction:
In the dynamic forex trading market where some strategies are conservative and some are bold, martingale strategy has a special place as a controversial yet attractive approach. In this article, we examine the mechanism of the Martingale system, its benefits and risks.
How does the martingale strategy work?
Martingale strategy is rooted in probability theory and its basic assumption is very simple. This strategy says to double your position size with every loss on the trade. Even after several losses in a row, because you have exponentially increased your position each time, as soon as you take a profit on a trade, all previous losses are recovered and net profit is achieved.
For example, let’s say you start trading with $100 and the first trade is a loss. Now you need to increase your position size to $200. If you lose again, you trade with $400, then with $800, and so on, until you get a profitable trade. After that, you should not double the position, but return to the base amount and open a new position with $100.
Is martingale suitable for forex?
One of the reasons why the martingale strategy is so popular in the forex market is that, unlike the stock market, currency pairs rarely reach zero. In the stock market, companies can easily go bankrupt. Regarding currencies, there are times when the value of a currency decreases drastically; But it rarely reaches zero.
The forex market has another advantage for using martingale, and that is that if the trader has enough capital to benefit from the martingale strategy, he can not only make a good profit, but also compensate for some of his losses. If you are a smart trader, just borrow using low-interest currencies and buy currencies with higher interest rates.
Trading with the help of martingale strategy in forex
To use the martingale strategy in forex, we act as follows:
1. Identify the right currency pair
According to the market conditions, whether it is trending or non-trending, we identify the right currency pair. We investigate the historical performance of that currency pair. This selected currency pair should historically have more profit opportunities than losses.
2. Place the first order with the selected currency pair
After identifying the currency pair, we open our first position. In bull markets, buy positions work and in bear markets, sell positions work.
3. Monitor the market
Right after the first order is placed, the real martingale strategy comes into play. We start monitoring the market and if the exchange rate of the currency pair decreases, we double our position. We repeat this several times (according to the maximum trading limit) until the price of the currency pair starts to rise again.
4. Exiting the position, when the profit exceeds the total loss
As soon as the exchange rate of the currency pair starts to rise and cover all our losses and reach a net profit, we exit the position.
A practical example of using Martingale in Forex
In forex trading, we deal with currency pairs, so trends are often long-term. Therefore, it may take a while for the position size to double. For example, suppose we want to trade the USD/EUR currency pair.
To begin with, we decide to first trade 1 standard lot with a leverage of 1:50 of this currency pair at a quote price of 1.1200.
The deal does not go as we think. The price drops to 1.1150 and we lose 50 pips.
Now we want to use martingale. Therefore, we need to double the position size to recover the losses. This time we buy 2 standard lots at the current exchange rate of 1.1150.
Again the price decreases and this time we lose another 50 pips in the transaction. Suppose the new exchange rate has reached 1.1100.
Again we use the martingale and this time we buy 4 standard lots of the selected currency pair at the current price of 1.1100. This time the market turns slightly in our favor and suppose we make 50 pips profit. Now the exchange rate has increased and reached 1.1150.
By doubling the position size and gaining 50 pips on the third trade, the loss of the first two trades is recouped. However, the net result is head-to-head.
Advantages of Martingale Strategy
First; Martingale is easy to understand and implement and does not require special technical knowledge of the market. Therefore, all traders from beginners to professionals can work with it.
Second; Loss recovery speed with this strategy is almost high. Even though short-term market movements are difficult to predict, if the trader has enough capital and doubles his positions, eventually a trade will pay off. Mathematically, assuming a random distribution of wins and losses, the exponential increase in capital will cover the losses.
Now the main question is whether all conditions will go as predicted on paper in the forex market with real transactions? How much initial capital does a trader have and how far can he continue?
Disadvantages and risks of Martingale strategy
We said that martingale strategy can be very risky. Let’s get to know its disadvantages.
1. Exponential losses
Although martingales have the potential to quickly recover losses, doubling the position size after each loss, especially in volatile markets, increases the loss exponentially until a win is achieved.
2. Market conditions
The main weakness of the martingale strategy is not taking into account the conditions of the forex market. It is naïve to assume that markets are random and that we will surely have a price increase after a few price cuts. The forex market can remain in a trend for long periods, and the martingale will progress until the trader’s account balance is completely depleted.
3. Limited initial capital
Many retail investors have limited initial capital. Even if you open your first position with $500, just 10 consecutive losing trades will result in a $50,000 loss. Do you think you should open the next position with such a loss? Yes; With a full lot. Many retail traders do not have a full lot at their disposal.
4. Account size and margin call
Margin is a guarantee that brokers receive from traders depending on the size of the account. Traders must have a large enough trading account to withstand consecutive losses. If a trader continuously increases his position during consecutive losses and runs out of balance before reaching a winning trade, his account will be liquidated.
5. Psychological stress as a result of reaching the risk tolerance threshold
Every trader can bear some risk. Most traders cannot increase their position size exponentially for very long and will soon reach their risk tolerance threshold. Consecutive losing streaks and doubling positions to recover losses may leave the trader feeling frustrated and anxious, leading to hasty and irrational decisions.
Tips for safe implementation of martingale strategy
There are some points that you can follow to implement the martingale strategy better ( note that even in this case, success in this strategy is not guaranteed ):
risk management
Very few traders successfully use martingales over long periods of time. Because the threat of multiplying losses and rapid reduction of profits to traders is serious. However, if you are determined to use this method, at least do not forget about risk management.
Your forex account should be significantly higher than the initial capital amount so that you can afford to double the initial amount even 20 times if needed. Also set a certain point so that the process stops before your account balance is exhausted or the margin is called.
position size
Carefully determine position sizes based on your account size and risk tolerance. Avoid excessively large position sizes that can lead to catastrophic losses.
Market analysis
Complement the martingale strategy with proper market analysis. Although Martingale does not rely on market forecasting, understanding market conditions and trends can help make informed decisions.
