- August 10, 2019
- Posted by: PurpleTrades
- Category: Stock Market
Martingale system 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 :
Say you bet 10 Rs on a Bet for Flip on the coin and choose Head, but say you get Tail and loose 10 rs.
Next time you bet 20 rs for Heads again and say you again get tail, you lost 20rs.
again next time you double and invest 40rs for Heads again and you get Heads and make 40 rs.
So Not only you made profits but recovered all your previous losses.
Thus 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.
Martingale system works well if the winning probability is 50% or more than 50%.
Lower the winning probability more the risk involved as you keep doubling your amount, you might end up being bankrupt in case you have a poor winning probability.
In the above example, we had a winning chance of 50-50, because either we will get Heads or Tails only, there is no Third option and hence Martingale system can give good profits.
However assume in the next case, instead of 1 Coin, Now we have three coins to be tossed together and you have to predict the Outcome, here the difficulty increases.
Earlier when there was only 1 coin, we had either Heads or Tails only, Now that we have 3 coins we have lots of Combinations.
Say you bet on 3 Heads (HHH),
But when coins are tossed the outcome can be among the following :
1 head and 2 tail (HTT)
1 Tail and 2 head (HHT)
3 heads (HHH).
So winning probability is 1 out of 4 cases i.e just 25% and hence using martingale, in this case, can wipe you your wealth.
But when it comes to the stock market, we have only two outputs,
Either stock will go in your favor or against you (Just like heads or tails) and hence betting on stocks using martingale can be profitable provided you know how to use it.
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.
and now 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.
Thus 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.
Now, at last, we have 2048 shares, which is almost 100 times the first bet of 2 shares, this impacts our ROI
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:
Didn’t understand the concept? Watch full explanation video here.