The Martingale System is one trading system that many people have heard of, but may not know the name. It was originally proposed as a gambling system, has been used a lot in Forex circles where sometimes it has been coded into Forex robots or expert advisors, and it is fundamentally flawed but still attracts an audience.
The system was made famous by an eighteenth century French mathematician. It can be summarized as a system of “doubling down” when you lose. Often explained in the context of roulette, where you would randomly bet on either red or black, it requires that each time you lose you double your next bet.
If you bet one on the first spin, and you won, you would be up one.
If you bet one on the first spin and lost, you would bet two on the second spin. If this wins, then the increased bet means that you would be up one overall.
Say the second bet above loses, you have lost three so far. Your third bet would double the second, so you gamble four. If you win this time, you again are one up overall.
It’s easy to see that the amount you have to bet increases rapidly, so you need large cash reserves to continue gambling – and each time after a winning bet, you finish with an overall profit of one. In fact, you will never have a series of bets, finishing with a win, where you profit more than one.
If you start with an infinite amount of money, you will always be able to place the next bet, so in simple terms you are “guaranteed” to win one, in the end. As no-one actually has an infinite amount of money, there is bound to be a losing streak, sooner or later, which is long enough to wipe you out. You can see that the risk to reward ratio is heavily weighted against you too, considering the system as a whole.
Even on the roulette table, it does not work out favourably. Recall that there are 37 slots, and only 18 reds and 18 blacks, so there is a bias in favour of the bank which is bound to make even an infinitely funded gambler lose in the end.
When you apply this type of system to trading, whether it is betting on Forex to go up or down, or using Contracts for Difference on any financial security choosing randomly to go long or short, you might think that if the price goes up as often as it goes down, the Martingale System could work, subject to having sufficient funding. That idea ignores the simple reality that trading costs money (remember brokers do make a living), and that money is often taken via spreads, interest charges, or sometimes commissions. Just like the double zero on the roulette wheel, even with an enormous amount of funds you are still bound to come out a loser.