Forex Trading with the Martingale Strategy

Forex Trading with the Martingale StrategyForex traders are constantly admonished to never add to a losing trade.

The rigidity of this rule if followed scrupulously when speculating on currency values should produce the effect of keeping every loss small and manageable, but it does mandate that there will be a lot of these small losses.

This fact of life of Forex trading compels many traders to consider the potential of using the Martingale Strategy during the course of their trading activities.

The term Martingale Strategy refers to a gambling strategy that was first popularized in 18th century France. The theory behind the strategy is that for every gambling event that produces a loser for the gambler, the stake for the next event is doubled. If one were to visit the local racecourse, it would be very likely to hear punters using the term “progressive staking” to describe this wagering approach.

While there are some valid comparisons between gambling and Forex trading, one vital difference must be acknowledged. All forms of gambling have a finite time period, while Forex trading has an infinite time period.

Even with this difference in mind, it is possible to apply a Martingale Strategy or Strategies to Forex trading. A hypothetical example using nice round numbers to make the math simple follows.

A trader, convinced that the Aussie is overvalued compared to the Kiwi dollar, sells 1000 units of the pair at S1.50. It turns out that the trader is wrong and the exchange rate rises to $1.75, meaning that the trader is losing money. Rather than meekly accepting the loss and moving on, he sells the pair again, this time placing an order for 2000 units at $1.75. This moves his average position price on the trade above his initial $1.50 entry to $1.66. Now, rather than needing the market to retrace $0.25 for his trade to be back at a break-even point (from $1.75 down to $1.50), he only needs it to come back $0.09 ($1.75 to $1.66) to break-even.

The arithmetic involved is simple. It is merely the average of 1000 units at a $1.50 and 2000 units at $1.75. This strategy is a complete contradiction of the admonition to never add to a losing trade.

An interesting variation that can be effective in real-world trading is that rather than double the number of units at the second entry point, it can be tripled to bring the average price very close to the market.

Applying this type of strategy in real-world trading requires careful analysis to determine how far to permit a trade to run into negative territory before adding the additional units. Some factors to consider when doing this analysis is to figure out the total range between the high prices and low prices for the time period that will be used to construct a Martingale Strategy.

Simply stated, whether you are selling in an uptrend or buying in a downtrend, you want to place the second and any subsequent entries far enough away from the initial entry to produce an average price as close as possible to where the trend against you has a reasonable probability of reversing or at least retracing enough to get back to your break-even point.

 

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