If you’re starting to take a more active role in trading and investing, you may have seen traders recommending a popular approach called the Martingale Strategy. On a basic level, the strategy is a theory of investment that allows for an increased amount for future investments, even when a valuation is falling.
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Key Facts About The Martingale Strategy
- The Martingale was founded by French mathematician Paul Pierre Levy in the 18th century.
- Casino goers have long used the Martingale System as a strategy for how to win roulette despite its associated risks.
- In the 20th century, it became highly popular as a Forex trading method.
- The system involves making an initial trade, which is then doubled after each loss.
- Theoretically, one “winning” trade is enough to recoup all previous losses.
Understanding the System
First and foremost, Martingale is far from being a risk-averse approach to investing. The idea is that statistically, it would be impossible to lose trades 100% of the time, so traders should continue to increase the amount allocated in investments in anticipation of future increases.
It relies heavily on the theory of mean reversion, which assumes that asset prices will converge to the average price over time. However, to see any positive results from applying the Martingale strategy, traders need a plentiful supply of capital in the first instance.
The easiest way to understand this approach is to use a wagering example, especially since Martingale is very similar to the casino gaming strategy of “doubling down” after a loss:
Starting with $10 capital, you place a $1 wager on a coin toss and win. However, after one win, you lose and then place $2 on your next wager and every wager until you start to win again and recoup your losses.
Popularity in the Forex Market
The Martingale strategy is most popular in the Forex market due to the fact that while there are times when currencies can experience a sharp decline, they rarely – if ever – drop to zero (unlike the stock market).
Another reason Martingale is so popular in the FX market is the opportunity to potentially offset losses with income generated from interest. Particularly astute traders combine the strategy with positive carry, borrowing using low-interest-rate currencies and then purchasing coins with a higher interest rate.
Given the similarities between FX trading and crypto trading, the Martingale system has become popular among the latter. When applied to crypto investing, traders decide whether they think a crypto price will increase or decrease, then invest a set amount accordingly. If the valuation falls, and they lose their investment, they double the investment on their next trade.
Risks and Rewards
A potential benefit of using a system like Martingale is that it can take the emotional charge out of investing. As a trading strategy, it features a clear and simple system to follow, enabling investors to make choices based on logic, not emotional responses.
As discussed in this article, it’s also a flexible strategy that can be applied to different investment scenarios since traders aren’t limited to purchasing one type of stock, currency, or crypto.
It’s important to remember, however, that no method of investment is inherently risk-free, and any rewards associated with it are entirely subjective. Furthermore, there are several drawbacks of using the Martingale that all potential investors need to be aware of.
For instance, doubling an investment for each loss made requires a significant pool of capital to begin with. Then, the risk-to-reward ratio of the strategy is disproportionately high, even when investing large amounts. Finally, even though the strategy itself is flexible, it doesn’t work in every type of market, especially those that are subject to several bear markets or crashes.