Martingale System

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. 

Understanding the Martingale System

The Martingale system 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 with, or at least enough money to make it to the winning payoff. Indeed, 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.

Why Martingale Works Better With Forex

Martingale trading a popular strategy in the forex markets. One of the reasons the martingale strategy is so popular in the currency market is that 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 offers another 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. That means an astute martingale trader may want to use the strategy on currency pairs in the direction of positive carry.

In other words, they would borrow using a low-interest rate currency and buy a currency with a higher interest rate.