If you consecutively lose money on trades and, to recover your losses, double your investment on each subsequent trade, you’re following the Martingale strategy. That way lies potential ruin .
Even on something with a certain probability of just one in two (50%), such as the toss of a coin, using the Martingale strategy has been proven, eventually, to bankrupt people.
To succeed using Martingale, you need an infinite amount of resources and an infinite amount of time. You have neither.
It gets worse. Stocks and shares, currencies and indices do not follow logical regular patterns but can behave unpredictably or be influenced by external factors, making the Martingale strategy doubly dangerous and trebly troubling.
The Martingale idea was used by French gamblers in the 18th century. It was first detailed in probability theory by Paul Levy in 1934 but previous work on probabilities by Richard von Mises in 1919 prompted Jean Ville to study the idea and coin the name Martingale in 1939.
The real development of the Martingale theory was then carried out by an American mathematics professor Joseph Doob and appeared in his work Classical Potential Theory and Its Probabilistic Counterpart in 1983.
The main impact was to convince casinos to bring in maximum bets and to add extra non-paying digits (0 and 00) to the roulette wheel.
That meant that while there remained a 50/50 chance of getting red or black, there were also two green slots that paid nothing.
As financial psychologist Kim Stephenson says: “Casino owners can afford to buy a new yacht as soon as the old one gets wet.”
The toss of a coin
You have £100. You need to make 10% profit or £10 a day. Your first bet is £10. If you win, you cash in. If you lose, you now have just £90 and you need to win £20 to make today’s target. You bet £20. If you win, you can stop. But if you lose, you now have just £70 left.
To make your 10% target, you need to bet £40. If you lose again, you now have just £30 left. That means you need to bet £80 to make your 10% target, so you need to borrow half your original stake, or £50.
You have had three flips of the coin and you are already deep in debt.
That kind of run of losses can, and does, happen. In 2001, Nasser Hussain, England cricket captain, famously lost 12 pre-match coin tosses in a row.
He was briefly absent for one game and his stand-in Marcus Trescothick won the toss for the first time. At the next England game, Hussain returned and lost the toss again.
If you lost 13 tosses in a row and you were following the Martingale method to earn £10 on the coin tossing example above, you would have borrowed £40,860, not including interest. Your next move would cost you more than £81,810, to win a tenner.
The theory is that with each trade, you increase the amount traded so that a success would secure not just the income you need but cover any losses made on previous trades.
Mathematically, if you had an infinite amount of money and time you would eventually win.
In reality, you will need so much money to place ever-increasing trades to cover the burgeoning losses that you will run out of money. Relying on Martingale has been shown to bankrupt people.
And that’s with a simple, guaranteed, 50/50 chance. Roulette has been changed to mean that you would lose even with infinite money and time. And markets are even less reliable than a roulette wheel.
Martingale theoretically works with infinite resources and time, assuming a fair game, with fixed risks and a known probability.
Here are just some issues that show markets do not work like that:
- A political or regulatory announcement can change the rules
- A company can act dishonestly and manipulate its figures or the market’s
- A rogue trader can cause a market to crash
- A natural disaster, accident, terrorist attack can cause a price to fall
- A new entrant or technology can disrupt and destroy a company or industry instantly
Basically, with markets, nothing is certain. There is no known probability.
Don’t do it
Martingale as an investment strategy is almost universally decried. Scour the web and you will find cases where using Martingale is not rejected outright, usually only when combined with strategies including:
- Investing in binary trades only (a price will rise or fall – similar to head or tails)
- Investing very small sums
- Restricting the total budget to as little as 2% of total investment capital
- Setting a maximum number of losses before cancelling the strategy
Financial psychologist Kim Stephenson has no advice for people on tempering the use of the Martingale method when trading. He offers no advice on when to use it or how to use it. His only advice is don’t. Don’t do it.