Money Management: Martingale
Oct 14, 2011 at 9:30 am in Risk Management by
It’s about time we talked about money management, and a good starting point is a discussion about Martingale and anti-Martingale betting strategies.
When you stake the equivalent of £100 on a long FTSE spread bet in the hope of making £100, and it goes wrong thereby losing you £100, what do you do? Do you stake £200 next time (for a £200 potential win) so that you make back your lost £100 and make £100 on top? If it goes wrong again, do you stake £400 on the basis that your luck must change eventually and — when it does — you’ll make back everything you lost… and more?
If you do this then you are following the Martingale betting strategy that was popular among casino players in 18th century France, and which is popular among many novice spread bettors even today. While this strategy must surely come good in the end, the end may be a very long time coming and the the meantime you need very deep pockets in order to sustain the exponentially-increasing bet sizes. And there are some other practical problems, like maximum bet sizes that might scupper your ability to actually place the all-or-nothing big bet that finally pays off.
While the Martingale strategy may indeed come good in the end when betting on stock indices which (unlike individual equities) don’t go all the way to zero and usually recover, most seasoned spread bettors – me included – know that ever-increasing bet sizes are a sure route to the poor house. So, in fact, they practice a form of anti-Martingale betting.
Suppose you start with a trading budget of £10,000, and sensibly you risk only 1% of it or £100 on your first trade. When it goes wrong, you are left with trading pot of £9,900. So in the next round you would risk a lower £99 which is again 1% of your trading budget. And so on, risking less and less money each time.
If you follow an anti-Martingale strategy, you won’t make a killing when your final big bet comes good, but at least you’ll ‘stay in the game’.
Now let’s look at this the other way around. The complement of throwing less and less money into a losing streak is to throw more and more money into a winning streak, possibly using the kind of pyramiding technique I talked about earlier. Sounds good to me, providing you only pyramid additional funds from profits that you have already locked-in with a stop order.
Here’s the real killer:
Apart from the problem of staying in the game long enough to turn a profit before you run out of cash, from a mathematical perspective it really doesn’t matter whether you follow a Martingale or anti-Martingale strategy. You will only turn a profit if you have an ‘edge’ that gives your trades a positive expectancy. Betting on coin 50/50 tosses doesn’t give you an edge (obviously), and neither does risking £100 in order to win £100 each on the FTSE as per my opening example. You need to do better than that!
Tony Loton is a private trader, and author of the book “Position Trading” (Second Edition) published by LOTONtech.