Tuesday, November 17, 2009

Deepest Pocket Wins ... Argumenting for Once and for ALL why Martingales CANNOT be traded Profitably in the Long Term

I have to say that I become a little bit irritated each time I go online and have a conversation with someone who argues in favor of martingale trading systems or when I see an EA seller selling this wonderful martingale expert that gives a 100% monthly profit. For this reason I decided to write this post today, this post will give all the arguments, once and for ALL that clearly show why Martingale trading IS unprofitable and CANNOT be traded profitably in ANY possible way. This analysis will also apply to any type of system with a similar progressive money management scheme. Before continuing, this post is not meant to be rude or mean against people who trade Martingale systems, this is merely to show you that it is not reliable and will eventually lead to the loss of all your trading capital.

As you all know, the Martingale system, developed in the 19th century, is a trading system in which a trader will double his stake when he loses a trade resetting the count after he wins a single trade. What is the problem with this ? Well, the first problem with this is the exponential increase in risk which make the system eventually risk very large amounts of money for very small profit amounts. I will now try to argument against each one of the points put forward by people who trade martingales :
  • If my account size is big enough it will not be wiped out. This is an awful mistake. Martingale systems will always wipe an account because the increase in risk is exponential while your increase in equity is liner. That is, increasing your capital from 1000 USD to 10,000 USD does not buy you 10 more losing trades, it just means 2 or 3 more losing trades. However, you will not lose 1000 you will lose 10,000 USD.
  • But if my system has X maximum consecutive loses then increasing my capital by Y will make the system safe. Wrong again. The fact that your system has X consecutive loses in historical testing or live testing does not mean it cannot have more. All trading systems may face a very large number of consecutive loses. In practice, you will never be able to sustain more than 10 consecutive loses, something which is likely to occur with almost any trading system. You are playing the deepest pocket game. In gambling, when two players are going for martingale strategies the one with the most money wins. Who has the deepest pockets, you or the market ?
  • Ok, I accept that my account will eventually be wiped out, however if I withdraw my profits I will still win in the end. This is a very naive argument in favor of Martingales. If wipeouts will always happen, which is the case, the frequency in which these wipeouts happen is unknown, so for example, you may get a wipeout in a month, then one next year then 8 the year after. In the end, a series of wipeouts will remove all profits from the previous runs in which the trader was lucky.
Can money be made from Martingale trading ? Of course, and money can also be made in Vegas. When you trade a Martingale system which is statistically shown to wipe any account and eliminate any accumulated profit either through succesive wipeouts of opened accounts or through the wipeout of a single account with all the profit you are simply betting on its success. Gambling is something that should not be done in trading. You know that there is a saying in trading. If you are going to gamble go to Vegas, at least the drinks are free. If you are considering or trading a Martingale take all the above points into account, they are based on sound and proved arguments.

If you would like to learn more about automated trading systems that use sound money management systems geared towards market adaptation and capital preservation please consider buying my ebook on automated trading or subscribing to my weekly newsletter to receive updates and check the live and demo accounts I am running with several expert advisors. I hope you enjoyed the article !

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