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Martingale systems do not work in Forex (2021)
Lately I've been reading in more and more trading forums that the Martingale strategy would be the perfect strategy and you couldn't lose with it in the long run. It would be the holy grail of trading strategies, so to speak. But what exactly is this strategy and is it really a recommendable strategy?
What is the Martingale Strategy?
The Martingale strategy, also known as Martingale, originally comes from the 18th century and describes a strategy in gambling in which you increase the stake in the event of a loss. To be precise, the stake is doubled in the event of a loss.
So you bet on the occurrence of a certain event. If this does not happen, you double the stake and bet again on the occurrence of this event. This continues until the desired event occurs.
An example using roulette
Let's take the game of chance roulette as an example. For example, you can bet on the colors (red or black). In the example, you now bet on the occurrence of a certain event. Let us assume that the last color in roulette was red. So you now bet on the opposite color, black.
For example, you start with one euro. Now the ball falls again on the color red. You now double the stake of one euro and bet two euros again on black. So you double the stake until you get the color you want.
This table shows how this strategy appears to work and how easy it is to use. However, this strategy does not work in reality.
Why doesn't the Martingale strategy work in roulette?
There are not only the colors red or black, but also green (the zero). That means, as soon as the ball hits zero, you have lost half the stake and you will be banned for the next round.
In addition, there is a fixed maximum stake in roulette, which is also known as the table limit.
A couple of math facts
There are 37 numbers in roulette. The numbers 1 to 36 plus the green zero. So there are 18 black and 18 red numbers.
The chance of winning is therefore 18/37 = 48.6%. This implies a loss probability of 51.4%.
This means that the chance of winning my stake on the next spin is always only 48.6%, while the probability that I will lose my amount and thus have to double my stake again is 51.4%.
The probability that if you bet on red and lose 7 games in a row is therefore (19/37)7 = 0,94% .
Despite this relatively small chance, you will never win enough in the long term to make up for such a series of losses. Since the profit only corresponds to the initial stake of 1 euro, you would have to win 127 times to make up for the loss.
It should be noted that the greater the losses, the greater the greater the odds of making a winner. The ball has no memory and will always land randomly on a certain field. The assumption that the probability of winning increases with an increasing number of losses is therefore incorrect.
This eliminates the use of the strategy in roulette for practical and mathematical aspects.
Using the Martingale Strategy in Forex Trading
Many will now say that this may be true in the casino, but in forex trading there is no zero, only long or short. In addition, there is no maximum bet like in the casino. So should the strategy in forex trading be successfully applicable or not?
What is important is that through this strategy too the probability of winning is not increased. The long-term gain is still the same. All the strategy achieves is postponing the losses. Given the right conditions, losses can thus be postponed enough that it looks like a safer opportunity to make a profit.
In trading, the Martingale strategy is a "cost-averaging" strategy that reduces the entry price with each doubling of the position size or increases it in the short case. The strategy doubles the position size until a winner occurs.
* When a pip is worth $ 10
In the example we buy 1 lot (100k) of the EUR / USD currency pair at a price of 1.18. Profit target and stop loss are 20 pips. So the strategy has 1R, as is typical for the Martingale strategy. For this reason alone, the strategy is not recommended, since the CRV is always only 1R. If one also assumes that the trader's hit rate is 50%, which is exactly what Eugene Fama said in a famous 1965 article "Random Walks in Stock Market Prices", it is a zero-sum game in the long run. In addition, however, there is still a high probability that the entire trading account will be destroyed at some point.
EUR / USD is running against us and has hit our theoretical stop loss. But instead of closing the position, as one should always do under the aspects of sensible risk and money management, we buy again. And this time 2 lots, so our break-even is not 20 pips, but only 10 pips. "Averaging down" by doubling the position size reduces the break-even point in order to be able to recoup the losses. After the fifth trade, the break-even point is 17.388 (rounded up from 1.173875). That means, if the price runs back to this point, we are back to +/- zero. When this level is reached, you can exit and cover all losses from previous trades.
By doubling the position size in each case, the profit target of 20 pips could be reached when the price fell to 1.1740. Because the average price was 1.17388 or 1.173875 and the exit was at 1.1740. A profit of 1.25 pips was thus achieved with 16 lots, which corresponds to a total of 20 pips.
Martingale strategy for stock market trading not recommended
With the Martingale strategy, a winner can cover the entire losses and the initial profit target can also be reached. This can also be seen from the following formula:
2n = ∑ 2n-1+1
That sounds tempting, but from the point of view of risk and money management, which are the essential foundations for long-term stock market success, absolutely not recommended. In this example, you risk 15 R for a trade of 1 R (corresponds to 100% based on the risk). This corresponds to a ratio of -15: 1. This is absolutely insane!
From a mathematical and theoretical point of view, the Martingale strategy should work, as the markets are known to move in drive and correction waves and every trend usually corrects at some point, but the point in time is indefinite.
In addition, the Forex markets tend to have very long trends. In addition, you would need an infinite amount of capital to experience this point in time, as a series of losses of 10 or more trades over time is very likely. In the above example, after only 4 losing trades, we already had a position size of 31 lots. That's the equivalent of $ 3.1 million. With 10 losing trades in a row, 2047 lots would be required. This equates to $ 204.7 million.
Even trading the smallest size, which would be a nano lot ($ 100), would still be $ 204,700. Although one works in forex trading with leverage, so that theoretically not the entire capital amount has to be available on the broker account in order to be able to trade the entire position, this is where the greatest danger lies with the Martingale strategy, especially in forex trading.
With a leverage of 1: 100, an account balance of $ 2047 would be sufficient to trade 31 nano lots. If the position continues to lose money, which is not unlikely, you have a loss that is 100 times the account balance. This illustrates once again the disturbed extent of this “strategy”. Fortunately, with many brokers, the losses may not exceed the account deposit, so that the stake is limited and therefore the strategy would not even be feasible (as with roulette). But even if brokers offer that the losses can exceed the account deposit, application of the strategy would sooner or later be the ruin of every trader.
Assuming that the trader trades with a leverage of 1:10 and his account deposit is $ 15,000, he could survive a maximum series of losses of 8 losers. Because then the capital investment would already be $ 10,230 (1023 nano lot x 100/10 leverage).
Math Facts When Trading Martingale Strategy
The more trades that are made with this strategy, the more likely it is to hit a long series of losses.
The statistical profile of this strategy corresponds to that of Taleb distribution. This means that the strategy has a payout profile with a small positive return, but carries a "low" but significant risk of total loss. You have a high probability of a small profit, but a low probability of a significant loss. The strategy payoff profile behaves differently than most strategies should. The expected value of this strategy is therefore even rather less than zero.
The risk increases exponentially with this strategy, while the payout profile of the profit is only linear.
If there are n losses, the trader's risk increases by 2n-1
If one assumes, as I said, that the hit rate is 50%, then the following profit expectation results from the trades:
Profit ≈ (1/2 n) x p
n: total number of trades
p: profit per trade
Using the example above, the trader sets a loss limit of 8 losing trades. The largest traded lot size would be 256 lots. This maximum amount would only be lost if there was a series of 9 losses.
The probability that this will happen is (1/2)9.
This means that you have to assume that the maximum loss will be reached every 512 trades.
After 512 trades:
- Expected wins: (1/2) * 29 x 1 = 256
- Expected highest loss -256
- The expected net profit is therefore 0
The Martingale strategy sounds very appealing at first glance, but the strategy is not recommended under any circumstances. Not even if the forex markets are trading in a range!
The strategy makes it clear that one should never expand loss positions in discretionary trading. Because that is often the beginning of the end. But what you can do is use an anti-Martingale strategy and increase your position if you are already ahead. This is also called pyramidizing. It is important, however, that the risk does not increase under any circumstances. The pyramidization strategy is only recommended for very experienced traders.
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