What is the Martingale system?
The Martingale system is a system of investing in which the dollar value of investments continually increases after losses or the position size increases with the lowering portfolio size. It is a methodology to amplify the chance of recovering from losing streaks. The main idea behind the Martingale system is that statistically, you cannot lose all of the time, and thus you should increase the amount allocated in investments even if they are declining in value in anticipation of a future increase.
It is essentially a strategy that promotes a loss-averse mentality that tries to improve the odds of breaking even but also increases the chances of severe and quick losses. Martingale trading is a popular strategy in the forex markets. One of the reasons the martingale strategy is so popular in the currency market is that currencies, unlike stocks, rarely drop to zero.
consider a trade with two outcomes with equal probability, Outcome 1 and Outcome 2. Trader X decides to trade a fixed sum of $50, hoping for outcome 1 to occur. However, Outcome 2 occurs instead, and the trade is lost.
Using the Martingale Strategy, the trade size is increased to $100, again hoping for Outcome 1. Again, Outcome B occurs, and the $100 is lost. As it’s a loss, the trade is doubled and is now $200. The process is continued until the desired outcome is achieved.