V.6:7 (265-267): Martingale money management by Robert Pelletier

V.6:7 (265-267): Martingale money management by Robert Pelletier
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Martingale money management by Robert Pelletier

An age-old method used by professional gamblers may be useful to the active trader as a means of money management. A martingale, according to Webster's dictionary, is a scheme for doubling your bet size following losses. The system is named after a successful 19th century gambler who frequented the casinos of the French Riviera. In a converted form the idea can be transformed into a mild progression which requires a slightly increasing wager level following losing trades and an equal or decreasing unit wager following winning trades.

To use the progression, trade size and win level per contract are assumed to remain constant. Admittedly, this assumption may not be realistic, but in the long run expected values should prevail. Another major assumption is that each trade is totally independent of all others.

How helpful can a martingale be? To give you an example, let's say that a martingale trade series is successful if it eventually wins a single trading unit—one contract or a single round lot of stock. Let's assume that the probable outcome of each trade is 50-50, win or lose. I have shown that a martingale series can improve the odds of a successful outcome from 50% to 87% with a minimum budget of four times margin plus six times average trade loss. Committing five times margin will increase the ultimate success rate of the series of trades to over 90%.

It is always possible to improve the odds of a winning series by adding to your investment reserve. However, no level of finite capital can deliver certain success and the size of the potential loss increases with the amount of capital committed.

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