FX Trading The Martingale Way
I mentioned the Martingale strategy a couple of weeks ago when I was focusing on money management.
http://www.forexproject.com/Blog/Investing_and_Trading/The_Martingale_Method/
There's a new article by Lien on Investopedia about the Martingale and its popularity with forex traders.
http://www.investopedia.com/articles/forex/06/martingale.asp
Even the Experts Do Not Make a Killing
I wanted to show Kathy Lien's and Boris Schlossberg's trading results for the last 2 months so that everyone can see what reality is. For those of you that don't know who they are, they both have written books on trading Forex, are both currency analysts at FXCM and they both regularly appear on CNBC. The results below are for the trades that they made public. What goes on behind the scenes is obviously unknown to me.
Their results are good; they made 366 pips between September 29th and today. I'm bringing it up because I think it's important to have realistic expectations when trading. When I first started trading, I thought it would be easier to make a living doing this. I quickly changed my thinking. Also, when you see "experts" making 366 pips in 2 months, you wonder how it would ever be possible to do this full-time.
If you average 400 pips every 2 months trading 2 100K lots, that's a total of 2400 pips over the year. That's approximately $24,000 a year. That's it! That's not a lot of money. I think the only way to do this for a living is to have plenty of capitalization so that you can trade more than 2 lots. In order for you to make $96,000 a year, you would need to trade 8 100K lots each trade. That would give you 4 times as many pips and therefore 9600 pips over the year.
How much capital would you need to start if you wanted to trade 8 100K lots with only a 3% risk per trade to your account. Let's use 30 pips as a stop loss for this example. If you lost 30 pips trading 8 lots, you would lose a total of $2400. Therefore, you need to have $80,000 in your account if you only wanted to risk 3%.
If my calculations are off, let me know but the reality is, even if you can consistently make good trades each and every month, you need a lot of capital to start to make a living. I'm assuming that you have to make $96,000 a year but some of you may require much less. For those of you in the New York City area like me, $96,000 isn't rich and I'm sure it's the same for a lot of other people in California or other parts of the country or world.
The Martingale Method
The Martingale Method is not a trading system, it is a money management method, moreover an interesting one. Follow with me because the logic is simple. You can read more about the Martingale Probability Theory here.
Martingale Method I
Assumptions:
- You are using a discretionary or mechanical trading system.
- You know your system well therefore you know how many consecutive losses your system has ever had. For this example, we'll assume your system has had at most 10 consecutive losses.
- You trade 3 lots.
Scenario:
- You have had 10 losses in a row trading 3 lots per trade.
Conservative Martingale Method I Example:
- On your very next trade after losing 10 in a row, increase the lot size to 4
- If this 4 lot trade is a winner, go back to normalcy trading 3 lots. Your done using Martingale for now
- If this 4 lot trade is a loser, increase the lot size to 5
- If this 5 lot trade is a winner, go back to normalcy trading 3 lots. Your done using Martingale for now
- If this 5 lot trade is a loser, increase the lot size to 6
- etc, etc, etc
Keep increasing lot sizes by 1 until you win. I think you get the point.
Martingale Method II
Assumptions:
- You are using a discretionary or mechanical trading system.
- You know your system well therefore you know the average number of losses your system has before turning a winner. For example, we'll say that on average, your system has 3 losses before turning a winner.
- You trade 3 lots.
Conservative Martingale Method II Example:
- You are currently not in a trade. You will wait until your system has 3 consecutive losses before doing anything. You WILL NOT trade.
- Once your system has 3 losses in a row, start trading your system again. Your first trade will be a 3 lot trade.
- If you win, great. If you lose, increase the number of lots to 4.
- Increase the number of lots until you win.
Aggressive Martingale Method II Example:
The only change here would be to enter your first trade with a larger lot size than normal after your system has 3 losses in a row. So instead of just trading 3 lots, trade 4.
Logical Stop Placement
Since I have deemed this week, "Money Management Week", I felt like I should mention a new Investopedia article titled, "A Logical Method of Stop Placement." I'm not overly impressed by the article but you might find it more useful than I did. The author gives a brief overview of 5 different types of stop methods:
- Hard stop – placing a stop a predefined number of pips away from the entry price
- ATR % stop – stop calculated by taking a percentage of the current ATR
- Multiple day high/low – placing stops at predetermined day's low or high
- Closes above/below price levels – placing stops above or below specific price levels (ie: double zeros)
- Indicator stop – stopping out a position based on the value of a certain indicator (RSI, ROC, CCI, etc)
You can read the article in its entirety.
Anatomy of a Trade
I just finished this flowchart that summarizes the flow of a trade using money management techniques. Of course, this is totally discretionary from the amount of lots traded, stop loss placement and target profit placement. If it's useful to me or you, maybe I'll add hyperlinks to pictures of chart examples.
What Everybody Ought to Know About Money Management
OK, so I'll admit that I'm using a catchy headline to force people to enhance their knowledge on the all important subject of Money Management.
I went to Borders yesterday to search for some literature on money management and found a majority of trading books having only one or two pages on the subject. I couldn't find a book dedicated to the subject, though I know there are several out there. One book I spent some time reading had a pretty large money management section. It was called "High Probability Trading" by Marcel Link. I didn't take notes though so I already forgot a lot of what I read. One thing I was able to take away from the book was the comparison between you as a trader and a casino. As a trader, you would benefit most by acting like a casino. The casino has established rules for their games that provide them with an edge. For example, with most bets in the game of roulette, the house has an edge of 5.26%. They are not concerned with any one person winning unless this person compromises this edge like counting cards. They are more concerned about all gamblers as a whole. The casino expects that in the long run, of all the money bet on the roulette wheel, they will come out on top 5.26%. I'm sure in most cases, it's a lot more. As a trader, money management isn't quite good enough if you don't have a system with some sort of edge. The bigger the edge, the better.
There is an excellent website on money management that I had talked about in a previous post months ago. The content isn't presented all that great though. Information is scattered and there are sections where the presenter just copies and pastes certain content relevant to the subject. Nevertheless, it is the best site I've seen out there that's dedicated to money management and I'll attempt to summarize the important points starting from the first section.
Source: http://members.aon.at/tips/moneyMan1.htm
"We cannot influence how the markets will behave, (therefore) we should
at least exercise control over those variables that we have actual
control of." This is where money management comes into the picture.
Q & A
Q. What is the difference between risk management and money management?
A. Risk management deals mainly with maximizing profits using
contract sizes. Money management deals mainly with minimizing losses
using stops as well as showing you when to take profits. You must have
both.
Q. What is the Percent Risk Model?
A. Simply, it is using a certain percentage of your capital for position sizing.
Q. What is constant risk?
A.
Adjusting your stops according to your system and peel off (reduce)
contracts when the risk got above the level you wanted to maintain.
Q. What is Market Wizard "money management" rule?
A. Always risk exactly 2.6% of total (closed + open) account equity on every trade
TIPS FOR FAILURE
- Trading 1 contract at a time will cause you to fail.
TIPS FOR SUCCESS
- The key is to have more positions when you are right and less positions when you are wrong.
- Stagger out of your trades when wrong or put another way, stagger your stop losses
- Hold on to all positions when right
- Never let a winner become a loser by adjusting your stops as the market moves with you
- Know
the Pareto Principle, also known as the 80-20 rule which when applied
to trading states that 80% of your profits comes from 20% of your trades - Stay with all of your positions until they meet the minimum profit objective
- Exit a portion of your trade at the minimum profit objective.
Hold the rest using a trailing stop to take advantage of huge trenders - Remain unbiased or without opinion as to the market direction.
Realize there is no such thing as overbought/oversold and no price is
too high or too low. - Like your losses because losing is a big part of trading and it also puts you one step closer to a winning trade
- Visualize what you want to accomplish before getting there
Money Management Week
I'm going to take the opportunity to call this week, Money Management Week. A lot of what I'll be posting will hopefully be related to this topic which probably means that website traffic will decrease. This would not be unusual considering that "on average, traders spend at least 10 times more time and effort on seeking the magic formula for trading than on learning to manage the trade." (Source: Matt Blackman, "Losing to Win")
I've been very aware of the fact that money management is the most important aspect of trading but hopefully by bringing this subject into the forefront this week will make you and I even more aware.
From a lot of the backtesting and forward testing I've done over the last year, it's become quite evident that winning percentage for most systems are below 40%. Some hover around the 40% level and others are even lower, reaching the 20%-30% level and below. According to Perry Kaufman, author of "A Short Course in Technical Trading" and a veteran trader, trend-following systems are the best trading systems around. But he also states that you can expect 6 or 7 out of every 10 trend trades to be losses, some small losses and some a little larger. For this reason, a lot of beginner and novice traders wonder how it's possible to ever be profitable trading.
The point is that the focus shouldn't be placed on how to achieve an unrealistic expectation for your win to loss ratio but to concentrate on money management. I'll admit that money management hasn't been my prime focus and it's reflected in the subject of my posts over the last year. In fact, I've only tagged 1 post with the subject money management attached to it.
This week I'll be gathering together some useful links to money management articles and I'll also be talking more about money management as it pertains to my trading. Larry Williams, a veteran trader said, "Since losses are an integral part of this game, a strategy is as essential as the proper attitude. All jobs have good days and bad days so deal with it…"
Money Management Rules
Forex2Stay has a very good blog post on Money Management. He has posted on this site before and uses the following formula to determine the size of a given trade:
S=(e*r) / (p-x)
Where:
S = Size of trade
e = portfolio equity(Cash and holdings)
r = maximum risk percentage per trade
p = entry price on the trade
x = pre-determined stop loss or exit price (based on TA)
Read the rest of his post at http://forex2stay.blogspot.com/2006/06/money-management.html
He mentions one gentlemen he met that makes money management his top priority and I checked out his site. He has some great stuff here: http://members.aon.at/tips/moneyMan.htm
I already like what I'm reading. Fear. I have fear of letting my winner run. I packaged these Money Management pages into a PDF.
Forex Money management 
