Martingale Trading Strategy: Principles of Martingale

Can you imagine having a method to recover from losses quickly to make a profit or, at least, reach the break-even point on the balance of a trading account? The Martingale trading strategy is a proposal to achieve such an ambitious goal. 

Understanding the principles behind the martingale as a betting system and acknowledging its limitations can help traders to effectively craft a trading strategy despite the gambling nature of the martingale. 

However, it is also a much riskier approach to trading markets, especially cryptocurrencies that tend to experience severe volatility. In this article, we will delve into those principles and how they work.

Martingale: The essence of a doubling technique

The martingale is a recovering technique based on a mathematical proposition used by investors to offset losing streaks by doubling bets in subsequent investment opportunities. It states that one successful bet is enough to gain even more after a loss.

Essentially, the mathematical approach leans on the promise of a potential mean reversion, that the odds of winning turning will increase in your favor over time as you cannot lose all the time. This way, the martingale technique increases the chances of overcoming losing periods at the cost of high-risks assumption.

This strategy requires high amounts of money to be effective and a loss-averse mindset. The central idea is to reach at least the break-even point of the account balance, although making profits is also an expectation.

Another aspect to remark from the martingale strategy is that while it proposes doubling after losing bets, it also reduces by half the bets for the winning streaks. In this sense, it tries to preserve the balance after winning periods but increases the risks during losing periods.

Principles of Martingale for Trading

The martingale was a system primarily used by bettors in the 18th century who tried to recover from losses quickly. It bears some crucial concepts that we can classify into principles to understand the basis behind the technique and how it works for trading.

1: Doubling

The focus of martingale is to increase by two times the size of the initial risk that a trader or investor is willing to assume.

In this sense, if a trader loses 1% in a trade, then in the next opportunity, the exposure will be 2%.

In the same way, an investor would increase his positions as the portfolio experiences a drawdown.

2: Probabilities

The martingale plays with the probabilities of a turning point in the price of an asset. The theory of mean reversion takes a relevant place and is the central concept behind this system.

As the price of an asset goes in a direction, it is likely to encounter a turning point for a reversal move. According to the Martingale strategy, traders must double the size of their initial risk during the reversal move for a trade after a previous loss.

To increase the chances of trading a turning point, traders might use concepts like support and resistance to identify demand and supply zones.

3: High amount of money

The effectiveness of this strategy will depend a lot on the risk management capacity of the trader, but most importantly, in the account balance.

The smaller the balance, the fewer the chances for it to be effective, as the martingale can quickly exceed the account balance before the reversion ensues. In contrast, an account with a big balance could resist various losing trades until it gets the right one.

Is Martingale A Trading Strategy Or a Gambling System?

It is valid to wonder if the martingale procedure can compose a trading strategy as it seems, at a glance, a gambling system. There is no doubt the nature of martingale is betting rather than systematically meeting a set of criteria to make a trade entry, as it would do, for example, strategies based on Price Action and SMC/ICT concepts.

However, the martingale can be convenient at specific moments and integrated into a trading plan as an extra resource if the market gathers the conditions for its implementation on high-probability setups. Therefore, traders can turn the gambling nature of the martingale method into a strategic approach.

This way, traders can avoid irrational behaviors like:

• Overtrading: When traders continuously trade following a losing streak.
• Ignoring Market Factors: Probabilities are not an isolated factor. Other fundamental factors can affect market sentiment and cause the price behavior of an asset to vary.
• Psychological Instability: The decision-making process of the traders can be severely affected, making them unable to stick to a plan after a losing period, or even worse, leading them to lose an account.

Considerations and Limitations of the Martingale System

A crucial matter to consider when integrating the martingale method into a trading strategy is its innate limitation for an exponential profit factor mindset. It means adding more to winning positions and cutting losses quickly. Martingale is the contrary to that, as we pointed out in the previous sections.

Every trader knows that growing an account balance requires the compound interest approach. More experienced traders can opt to double during winning trades and reduce the size of trading exposure during losses.

The martingale poses a critical limitation in this subject, as it reduces the position size as the winning trades emerge but proposes doubling after losing trades. In this sense, traders must consider the options and possibilities for the best trading setups, wisely choosing when would be more convenient to use the martingale and when not.

Conclusion and Call to Action

Derived from a mathematical system used primarily by bettors, the Martingale strategy has found its place in trading despite the potential gambling behavior it could lead traders to. 

The method promises a recovery after a loss by applying the principles of doubling the position after a loss, seeking a possible turning point in the price based on the mean reversion theory, and where the quantity of money available will play a noteworthy role.

The effectiveness of a trading strategy based on the martingale will depend on distinct risk factors related to behavioral and market conditions that traders cannot ignore.

In Altrady you can use features related to smart trading and risk management that can serve as a basis to craft an effective strategy. Enroll in a free trial account with paper trading and start testing martingale techniques today.