Thinking of Using a Martingale Strategy?

In a previous post I wrote about a so-called trading strategy that is presented to traders in Binary Options as a virtually sure way to win. Click here to view that post.

In fact, as we showed, it was nothing of the sort and actually amounted to a virtually sure way to lose your whole fund.

What’s wrong with using Martingale?

The main problems were that there was no actual market analysis included and it was really just a Martingale betting strategy dressed up a bit.

According to Wikipedia, because it is very easy to learn and the maths appear to give a clear result, it ‘makes the martingale betting strategy seem like a sure thing. However, the exponential growth of the bets eventually bankrupts its users’.

There you have it, I can’t say it any more clearly except to note that this conclusion is based on a true martingale where you win back your full stake.  That the payoff ratio is less than 100% when trading Binary Options means you will lose you money all the more quickly if you employ this ‘strategy’.

What can you expect?

I ran a simulation of 500 trades based on a 75% payout ratio with a 50% probability of winning i.e. trading randomly with no benefit from whatever market analysis is being undertaken. We would not expect this system to be profitable.

However, if we employ a simple Martingale strategy where we risk 2% on the initial stake i.e. the next trade following a win, then we lose all our money after just 110 trades.

The reason you lose all is the usual one – you hit a string of losing trades. In this case it was a string of 6 losers with the result that the required stake to continue the system was actually greater than the initial fund.

You lose all your money – quickly

Then the next trade was also a loser. Even if this had not been the case it was only a short time later that we hit another string of 6 losers with the same result.

The chances of a string of 7 losers that wipe out our fund is only 1 in 128. But this means that we can expect it to happen about 4 times over the course of 500 trades. That it happened after 110 trades in our simulation is right in line with expectations.

Reducing the size of your initial stake is not a solution. If we run the simulation again but reduce the initial stake to just 0.5% of the starting fund then we still lose all our money over a similar number of trades.

At lower stakes then you don’t actually ever go bankrupt on this simulation but neither is the system profitable.

Doing the exact opposite might be better!

If anything, a strategy based on the exact opposite, known as an anti-martingale strategy, could have some limited validity when trading financial markets. In this case you double your bet if you win and go back to the initial small bet if you lose.

Think about it. Markets do trend i.e. move in a particular direction over a period of time. Let’s say that for whatever reason, whether by luck or good market analysis, you place a trade and it wins.

Place another trade in the same direction for a larger stake, multiplying the previous stake by the inverse of the payout ratio. Keep doing this until you lose and you will have a small profit provided you have a number of instances of at least two successive wins.

I’m not advocating this as the risk reward ratio, or return on investment, would be unacceptably low.

Employing this approach to the simulation meant we did not lose all our money until after about 340 trades. But lose it all we did. The system would keep you solvent over 500 trades if you limit your stake to 1% of your fund but eventually you will lose all.

The conclusion is clear

To be fair, because we were using a random distribution of trades then there were no real trends and so somewhat better results might be obtained in actual markets using an anti-Martingale system.

However, the conclusion is clear: a system such as this is not a trading strategy and has no place when trading Binary Options.

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