|Your Bet||Wager||Flip Results||Profit/Loss||Account Equity|
|Heads||$ 1||Heads||$ 1||$11|
|Heads||$ 1||Tails||$ (1)||$10|
|Heads||$ 2||Tails||$ (2)||$8|
|Heads||$ 4||Heads||$ 4||$12|
Assume that you have a total of $10 to wager, starting with a first wager of $1. You bet on heads, the coin flips that way and you win $1, bringing your equity up to $11. Each time you are successful, you keep on betting the same $1 until you lose. The next flip is a loser and you bring your account equity back to $10. On the next bet, you wager $2 in the hope that if the coin lands on heads, you will recoup your previous losses and bring your net profit and loss to zero. Unfortunately, it lands on tails again and you lose another $2, bringing your total equity down to $8. So, according to martingale strategy, on the next bet you wager double the prior amount to $4. Thankfully, you hit a winner and gain $4, bringing your total equity back up to $12. As you can see, all you needed was one winner to get back all of your previous losses.
However, let's consider what happens when you hit a losing streak:
|Your Bet||Wager||Flip Results||Profit/Loss||Account Equity|
Once again, you have $10 to wager, with a starting bet of $1. In this scenario, you immediately lose on the first bet and bring your balance down $9. You double your bet on the next wager, lose again and end up with $7. On the third bet, your wager is up to $4 and your losing streak continues, bringing you down to $3. You do not have enough money to double down and the best you can do is bet it all. If you lose, you are down to zero and even if you win, you are still far from your initial $10 starting capital.
You may think that the long string of losses, such as in the above example, would represent unusually bad luck, but when you trade currencies, they tend to trend, and trends can last for a very long time, if you are caught in the wrong direction. The key with martingale, when applied to trading, is that by "doubling down" you in essentially lower your average entry price. In the example below, at two lots, you need the EUR/USD to rally from 1.263 to 1.264 to break even. As the price moves lower and you add four lots, you only need it to rally to 1.2625 instead of 1.264 to break even. The more lots you add, the lower your average entry price. Even though you may lose 100 pips on the first lot of the EUR/USD if the price hits 1.255, you only need the currency pair to rally to 1.2569 to break even on your entire holdings.
This is also a clear example of why deep pockets are needed. If you only have $5,000 to trade, you would be bankrupt before you were even able to see the EUR/USD reach 1.255. The currency may eventually turn, but with the martingale strategy, there are many cases when you may not have enough money to keep you in the market long enough to see that end. (To learn more, see Common Questions About Currency Trading.)
|EUR/USD||Lots||Average or Break-Even Price||Accumulated Loss||Break-Even Move|
Why Martingale Works Better with FX
One of the reasons why the martingale strategy is so popular in the currency market is because, unlike stocks, currencies rarely go to zero. Although companies easily can go bankrupt, countries cannot. There will be times when a currency is devalued, but even in cases where there is a sharp slide, the currency's value never reaches zero. It's not impossible, but what it would take for this to happen is too scary to even consider.
The FX market also offers one unique advantage that makes it more attractive for traders who have the capital to follow the martingale strategy: The ability to earn interest allows traders to offset a portion of their losses with interest income. This means that an astute martingale trader may want to only trade the strategy on currency pairs in the direction of positive carry. In other words, he or she would buy a currency with a high interest rate and earn that interest while, at the same time, selling a currency with a low interest rate.With a large amount of lots, interest income can be very substantial and could work to reduce your average entry price. (For related reading, see Trading The Odds With Arbitrage.)
The Bottom Line
As attractive as the martingale strategy may sound to some traders, we stress that grave caution is needed for those who attempt to practice this style of trading. The main problem with this strategy is that oftentimes, seemingly sure-fire trade may blow up your account, before you can turn a profit or even recoup your losses. In the end, traders must question whether they are willing to lose most of their account equity on a single trade. Given that they must do this to average much smaller profits, many feel that the martingale trading strategy is entirely too risky for their tastes.
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