MARTINGALE MONEY MANAGEMENT

The martingale category simply states that as the value of an accountis decreasing, the size of following trades increase. The basiccharacteristic of the martingale is that as the account suffers losses,the ability to make up those losses either increases or stays the same.This is a popular type of money management for gamblers. As statedin Chapter 2, no type of money management can turn a negative expectationscenario into a positive expectation. As a result, gamblersare not trying to change the odds, but rather are trying to take advantageof streaks. Consider the following example.Flip a coin 100 times. You have a choice to bet on either heads upor tails up on each flip. However, when you win, you only win $4 andwhen you lose, you lose $5. This is a negative mathematical expectation.If you were to bet $5 every flip of the coin, you would end up losing$50 after 100 flips of the coin:However, you will only bet after a streak of three in a row andyou will bet opposite of that streak. Therefore, if the coin lands headsup three times in a row, you will bet the next flip of the coin to betails up. If you lose, you will double your bet on the next flip to betails up. If you lose again, you will double your bet on the next flip tobe tails up. After three losses, you will quit.For the illustration, I actually flipped a coin 100 times to come upwith the streaks to simulate actual performance. Out of those 100flips, there were 16 streaks of 3 in a row of either heads or tails. Outof those 16 streaks of 3 in a row, 10 generated an opposite result ofthe streak on the very next flip. For those 10 times, we won $4 perwin, or $40 total. There were three times that generated an oppositeresult after the fourth flip. For those three streaks, we lost $5 on thefirst bet and won $8 on the next. We came out $9 ahead for those threetimes, bringing our winnings up to $49. Twice, the streak went 5 in arow and then generated an opposite result on the next flip. For thosetwo streaks, we lost $5 on the first bet, $10 on the second bet, andwon $16 on the third bet for a net of only $1 each time. This broughtour total winnings up to $51. However, there was one streak thatlasted tails up 8 consecutive times. For this streak, we lost $5 the firstbet, lost $10 the second bet, and lost $20 the third bet and had to quit.For this streak, we lost a total of $35. This brought our total winningsdown to only $16.This is a classic example of gamblers trying to take advantage ofstreaks. The only way they lose in this situation is if the streak lastsfor 6 consecutive flips. However, this is still not a positive mathematicalexpectation. We discuss the mathematics of streaks later in thebook. For now though, I think it is enough to let you know how thenext set of 100 flips went. On the next 100 flips, there were 9 streaksof 3 consecutive flips heads or tails. Only 4 of them, however, generatedan opposite result on the fourth flip. With those 4 streaks, thewinnings were $16. Only one streak generated an opposite flip on thefifth flip of the coin. With that streak, $3 was added to the total,which now stood at $19. Two streaks ended on the sixth flip of thecoin bringing in $1 per streak and the total to $21. There were twoflips that lasted for more than 6 consecutive heads or tails. For each1820 TYPES OF MONEY MANAGEMENT ANTIMARTINGALE MONEY MANAGEMENT 21of those streaks, losses of $35 per streak were realized. This broughtthe total for the second set of streaks to negative ($49) and the totalbetween both sets at negative ($33).The theory behind doubling the size of the bet is that eventually,the streak has to come to an end. If you were to double $100 tentimes, however, you would end up with $102,400. At twenty times, youwould end up with $104,857,600. At thirty times, you end up with$107,374,182,400. One of two things will happen eventually. Eitherthe streak will end, or you will run out of money completely. Thismeans that going through the sequence enough times, you will, eventually,run out of money because you only have to do that once and itis over.The martingale theory does not mean that the following tradeshave to double in size. For example, a trader is trading 10 contractswhere the potential loss on any given trade is $1,000 per contract andthe potential win on any given trade is $800 per contract (no exceptionsfrom these two figures for the sake of the example). If he suffersa losing trade, the total loss on the trade is $10,000. To make upfor that $10,000 loss, the trader might increase the number of contractsto 13 on the next trade. This would bring in a total of $10,400if the next trade were to be a winner. If it is a loser, however, the losswill be at $13,000 for the trade and $23,000 between the two. Thetrader has a couple of options at this point. The next trade size cantry to make up for the total loss (29 contracts and not really an option)or it can only try to make up for the previous loss (17 contracts).Obviously, this is not a very good situation either way. The trader islooking at $40,000 in losses minimum should the third trade be aloser and up to $62,000 in losses at 4 losers in a row.These are but a few ways of using martingale money managementmethods. This type of money management is definitely notrecommended for the futures, stock, or options trader. The risks arefar too great and there are better, more efficient methods to managethe money.