Recently, some people started advertising martingale money management to the binary options community, and some robots and auto traders for binary options started using martingale money management systems. These developments are the reason why it is important to understand the difference between a conventional and a Martingale money management system.
For binary options traders, martingale money management systems are a disaster. In this article, we will explain why. In detail, we will answer these questions:
- What are martingale money management systems?
- Why are martingale money management systems dangerous for binary options traders?
- What are better alternatives to martingale money management systems?
With the answers to these questions, you will be able to deal with martingale money management systems effectively and replace them with a money management system that can make you money.
What are Martingale money management systems?
When you want to make a trade, you need to answer a simple question: how much money do you want to invest in this trade? A money management system helps you to answer this question. Martingale money management systems are one form of money management systems that have come up with a very unique form of an answer to this question.
To understand how martingale money management systems work, consider this simple example:
- You invest $10 in a trade.
- You lose this trade. Your balance is down $10.
- You double your investment and invest $20 in the next trade.
- You win this trade, make a profit of around $16 and end up with a $6 profit.
This is the basic idea of martingale money management systems. After a loss, you double your investment until you eventually win a trade. Once you do win a trade, your profit will make up for all your prior losses. In this form, your profit is guaranteed.
The simplest version of a martingale money management system is a well-known example from roulette: A trader bets on either red or black. If he loses, he doubles his investment. He repeats this process until he eventually wins a round. Ideally, this strategy will always win him the amount he first invested.
At first, this approach might sound promising. But there are many problems with martingale money management systems that make them difficult to use with binary options. Let’s take a look at these reasons.
Do Martingale Money Management systems work with binary options?
The logic behind a Martingale money management system is that if you have lost money, you have to invest more to win the lost money back. Every time you lose, you increase your investment. This is a very different idea than the approach that conventional money management systems take.
The logic behind money management is simple: Every trading strategy will eventually cause a number of losing trades in a row. Binary options are a numbers game, and no trader will win all of their trades. Consequently, the sheer power of the odds dictates that the inevitable losing trades will sometimes occur in bulk in some places.
Surviving these losing streaks is the first order of business for every trader and the main goal of a money management system. After all, even the biggest profits are worthless if a losing streak can wipe them all out.
To survive a losing streak, a trader needs to limit their investment per trade. A trader that invests half of their account balance on a single trade can lose 75 percent of their money with only two lost trades in a row and this trader would need to double their account balance twice just to get back to where they started.
Money management systems are supposed to guarantee that you survive losing streaks and grow your capital when things are going your way. To achieve these goals, a conventional money management system orders a trader always invests a small percentage of their total capital in every trade. This percentage should be less than 5 percent, with risky strategies even less, maybe 2 percent.
Put into practice, such a money management system would do the exact opposite of a martingale money management system:
- A trader with a total capital of $1,000 who invests five percent of their total capital per trade, for example, would invest $50 for each trade. Where a good money management provides you with a definite number for how much to invest, martingale money management systems would leave this first decision up to you.
- As their bankroll increases, traders with a good money management would increase their investment per trade accordingly. When the trader in our example reaches an account balance of $2,000, they will invest $100 per trade. With a martingale money management system, they would decrease their investment per trade after every winning trade and start the cycle anew.
- Should traders with a good money management system lose money, they would decrease their investment per trade accordingly. Should the trader in our example suffer a losing streak that takes them back to $800 overall, they would reduce their investment to $40. With a martingale money management system, they would increase their investment to possibly insane amounts.
With a Martingale money management system, traders do the exact opposite of what they are supposed to do: they increase they investment after a loss, and they decrease their investment after a win. This approach is a huge problem.
Throughout history, many people have used martingale money management systems in all sorts of investments. They all encountered the same two problems that binary options traders will face two if they use a similar money management:
1) Limited capital
The most obvious problem with a Martingale money management system is the limited capital of the investor. For a martingale money management system to work, you would have to be able to double your investment per trade indefinitely. This is simply not the case.
At some point, increasing the invested capital becomes impossible. Maybe, the trader does not have enough money left, or they are reluctant to invest half of their account balance on a trade and exit the cycle before it is too late.
Now, you might say that such a development requires a relatively long losing streak. Many traders have made similar arguments, but they all found out the same thing: if you plan to earn money with binary options, you will be investing for a long enough amount of time that such a losing streak is inevitable.
Since every round of Martingale investing prior to your losing streak can at best generate a return on your initial investment, but a losing streak will cost you hundreds of times your initial investment, such a losing streak will wipe out all prior gains you made using a Martingale money management system.
2) Unfair odds
A Martingale money management system implies that, with every turn, you have an equal chance of winning or losing the same amount of money. In reality, though, this is almost never the case. With high / low options, for example, you will receive a payout of at best 75 percent your investment. If you lose a trade, however, you will lose 100 percent of your investment.
This means, after you lose your first trade, you have lost one investment (1 I). With the Martingale money management systems, you will invest twice the amount on your second trade (2 I). Even if you win this trade, you will only win 75 percent of your investment for this trade, which is only 1.5 times your original investment (2 I x 0.75 = 1.5 I). This shows the dilemma of the martingale money management system: Your odds are constantly getting worse.
If you lose your second and your third trade, you will invest eight times your initial investment with your fourth trade. By this time you have invested 1 I (first trade) + 2 I (second trade) + 4 I (third trade) = 7 I. Your investment of 8 I on the fourth trade, however, can only win you 8 I x 0.75 = 6 I. That means, even if you win your fourth trade, you will lose the amount of your initial investment. Since 75 percent is a relatively high estimate for a payout with high / low options, your odds in real life trading are even worse.
The same math applies to any kind of binary option. While touch options offer a higher payout, your binary options broker will calculate the payout always in a way that makes using a martingale money management system unprofitable.
In conclusion, the Martingale money management systems will work perfectly, at first. Sooner or later, however, you will encounter the severe problems that come with a Martingale money management system. Combined with binary options, a martingale money management system will certainly fail. If your auto trading system offers a Martingale money management, make sure to deselect it. If you are trading manually, do not use a Martingale money management system either.
3) A martingale money management system is less profitable
Some traders believed that they could handle the points that we made so far by simply starting the cycle of their martingale money management system with such a small investment per trade that they could afford to double the amount for a large number of losing trades.
For example, if such a trader had an account balance of $1,000, they would invest only $1. They thought that such a small amount could never fall victim to the odds that we described above. Let’s analyze these hopes.
- Chance: Starting with an investment of $1, your most likely outcome is a profit of $0.80. Compared to an account balance of $1,000, every cycle of your martingale money management system could earn you about 0.08 percent of your overall capital.
- Risk: Starting with an investment of $1 and an account balance of $1,000, it takes only nine losing trades until you run out of all your money. Now, such a losing streak will only happen every 3,814 trades, but as a binary options trader, you can easily place 5 trades a day, which amounts to 100 trades a month (assuming 20 trading days), and over 1,200 trades a year. Consequently, you could be certain to lose all your money every three years. After one-and-a-half years, your chances would be 50/50 already, and within one year you would have a 30 percent chance of ending up broke.
- Chance / risk relationship: Ask yourself: When you take a 30 percent chance of losing all your money within one year, is a 0.08 percent gain per cycle really worth it? Assuming that an average cycle takes three trades, you could at best gain 38 percent, but you could lose everything.
With a conventional money management system, the odds are more in your favor. Complete loss is almost impossible, but you can gain significantly more than 38 percent. This is why martingale money management systems are not only too risky but also not profitable enough to be employed with binary options or any other type of serious investment
With a martingale money management system you will make almost no profit, and then you will lose everything.
Better alternatives to martingale money management systems
Ok, so if a martingale money management system can’t make you rich, then what can? Well, we already outlined the most important criteria for effective money management: investing a small percentage of your overall account balance per trade, ideally somewhere between 2 percent and 5 percent. With such a money management system, you can’t go wrong. There are, however, a few more points you should consider:
- Never invest all your money at the same time: When you invest 5 percent of your account balance per trade, it only takes 20 trades until you have invested all your money. Traders that use long expiries might invest all their money at once, which is a bad idea. Firstly, you might find an almost guaranteed winner but lack the money to take advantage of it. Secondly, you never know what happens. An unlucky turn of events might mean that you lose half of your trades and end up with half your account balance wiped out. To avoid such a disaster, we recommend never to invest more than 20 percent of your overall capital simultaneously.
- Spread your money across countries: Many assets are connected. When stocks in the U.S. have a good day, you might predict rising prices with all of your positions. In this case, one bad news event might force the market down, and you would lose all your trades. Such connections between assets are the reason why you have to diversify your investments. When you invest in similar assets simultaneously, you really invest in the same developments, which means that you invest much more money in a single event than the 5 percent your money management allows you. This is especially relevant for traders who invest in stocks. The Euro/U.S. Dollar pair depends just as much on the Dollar as the British Pound/U.S. Dollar pair, which is why news influencing the Dollar can cause you to lose both trades.
- Spread your investment across industries and asset types: Similar to what we said about spreading your investment across countries, you should also make sure to spread your investment across industries and asset types. When you invest all your money in car makers, choosing car makers from different countries will do little to protect your money. Plummeting car sales in the U.S. will cause both Ford’s and BMW’s stocks to fall, even though they are from different countries.
Follow these rules, and you will manage your money much more effectively than with a martingale money management system. The result will be higher profits and less risk.
Martingale money management systems are an ineffective way of managing your money. Because they want you to increase your investments after a loss, you would need an unlimited amount of money to execute them successfully. Since your resources are limited, you will sooner or later face a losing streak that ruins you.
At the same time, the long-term profits you can make with martingale money management systems in a best case scenario are lower than with conventional money management systems. Combining high money with very limited potential, binary options traders should stay away from martingale money management systems.
To manage your money more effectively, invest a small percentage of your total account balance per trade, never invest all of your money, and spread your money across industries, countries, and asset types. With such a money management, you will be able to create long-term success.