Martingale is a type of betting strategy introduced by French mathematician Paul Pierre levy, which became very popular among gamblers of France in the late 18th century.
The basic rule of the martingale system is:
If you lose in a bet(trade), double your quantity in next bet( trade) and keep doubling until you win, this way you will recover all the losses in previous bets(trades).
The concept is quite simple :
If I bet 10rs in trade and lose it, next time I would bet 20rs and if I lose it, I would take next bet of 40rs. If I Win this bet(trade), I make 40rs which will recover my 30 rs lost in previous 2 trades (10rs and 20rs respectively), and net I will be having 10rs profit.
So martingale rule for normal bets where the probability of winning is 50-50, will only help you get the profits equal to your first trade.
Let us understand with one example on Stocks :
Consider X stock whose CMP is 100rs. And I wish to Bet on the direction it would move without any technical or fundamental study. Let’s say I want to just speculate and catch profits if I am lucky!.
In that case, martingale can help me as following :
Say I buy 500 shares of X stock at INR 100rs each, Investing 50,000 rs and my target is to make 2000 rs per trade.
So If CMP of X stock goes up to 104, I would sell and make a profit of 2000 rs or if it goes against me to 96, giving e a loss of 2000 rs.
I would double my quantity (buy 500 more shares) and continue to do so till I win a trade. But in spite of all these efforts, I would still be able to make only rs 2000 as my net profit, which I was supposed to get in my first trade.
The calculation for the same is as follows:
Say I bought 500 shares at CMP 100 rs, and stock slides down to 96, (loss of 2000rs), I book this loss and next trade I will double my quantity.
I buy fresh 1000 more shares at CMP 96, and again stock slides down to 92, (loss of 4000 rs), I book this loss and next trade I will double my quantity.
I buy fresh 2000 more shares at CMP 92, and again stock slides down to 88, (loss of 8000 rs) I book my loss and I will again double my quantity.
Now I will buy 4000 shares at CMP 88, and now if the stock goes in my favor by 4 rs from 88 to 92,
I would get 16000 rs profit in the new position.
So my net profit is 16000 – 8000 – 4000 – 2000 = 2000.
So after doing all of this I just made a net profit of 2000 rs only, which I could have made in my first trade, had the trade been In my favor.
So, clearly, the martingale system is profitable only and only if you keep putting money in your trade and you have unlimited wealth to keep doubling on your losing trades.
If you run out of money or if stock is continuously going against you, you can become bankrupt.
Thus the theoretical idea of Martingale looks very fancy and attractive, however, in reality, it is not profitable in long run because of the fact that you keep doubling every time you lose and in no time your quantity becomes so huge that you will get a panic!.
Say you start with only 2 shares of stock add lost 10 times in a row using martingale and at 11th trade, you will have this :
1st trade = 2 shares
2nd trade = 4 shares
3rd trade = 8 shares
4th trade = 16 shares
5th trade = 32 shares
6th trade = 64 shares
7th trade = 128 shares
8th trade = 256 shares
9th trade = 512 shares
10th trade = 1024 shares
And at 11th trade, you will have 2048 shares,
which is 100 times bigger than your initial quantity (2 shares) just to give you the same profits what first trade of 2 shares would have given you. Which destroys our ROI also.
Next Big question :
So is there a way to make money using the Martingale system in the stock market ??
We have answered this question In our next blog :
READ IT HERE!!!
Didn’t understand the concept? Watch full explanation video here.