Having a good money management strategy is essential in earning money through options trading. You need to focus on minimising losses and then on gaining profit. You will be left with some gains only when winning trades will exceed lost ones.
And what to do when you experience a loss? You have to think about how to adjust to such a situation in order to protect the capital that is left. You might think the best way to go would be to reduce the investment amount for the consecutive trades. Surprisingly, there is a strategy called the Martingale money management strategy, that advise the opposite. We will take a closer look at it in this article.
- 1 The basics of the Martingale money management strategy
- 2 Is the Martingale strategy applicable to options trading?
- 3 Hints on how to apply the Martingale strategy to trading options
The basics of the Martingale money management strategy
The main rule in the Martingale system says you should increase the amount you put in a single trade every time you lose. So if one trade was lost, you multiply the investment amount for the next transaction. If you lose again, you will continue to increase the amount of money. And when you finally win, you will then return to a small initial investment amount.
What is the reasoning behind such a trading system? Why increase the amount when you are losing? Martingale experts claim, that this is the best way to compensate the loss. When you finally win, the amount will cover what you lost. If you put every time the same amount, or even lower, then the winning transaction will cover only part and you will end up in debt.
Some treat the Martingale strategy like betting. There are always 50/50 chances a trade will win or lose. Moreover, it is very unlikely to open an infinite series of losing transactions. And with every trade you make, the probability of the next failure diminishes.
Is the Martingale strategy applicable to options trading?
Probability and psychology
Looking at the Martingale money management strategy from a probabilistic point of view, it is possible to apply it in options trading. There are always 50% chances of winning, as well as 50% chances of losing. Furthermore, it is not probable to fail forever, so with every transaction, you are closer to success.
Now, looking from a psychological point of view, the Martingale strategy does not look so good.
There is nobody who would be happy losing cash. Every trader should be ready for some losses, but when it happens continuously for a certain period of time, the fear and anxiety will grow. And these are the emotions that might interfere with decision making.
Negative emotions will also arise when a few transactions are successful and then, suddenly a big loss occurs. So the initial motivation and joy are replaced by the disappointment and dismay.
No long term profitability is available
You need to have a massive initial capital at your disposal to use the Martingale system. You may open several small successful transactions and then a big loss can ruin your work.
The strategy assumes that the winning trades will offset the previous losses. But the profit that you will end up with may not be big enough to be a justification for a giant investment in this one-time trade.
Winning trades are not guaranteed
Martingale enthusiasts will persuade that it is not possible to get an infinite amount of lost transactions. However, it is possible to fail so many times that your resources will be completely exhausted.
While you may finally perform a winning transaction, it might be not big enough to cover the loss and finish the day with a profit on your account. There will be simply less and less money on your account.
The primary focus is on protecting your money
The first thing you should take care of is your money and protecting them. You are an options trader and your money is the way to make more money for you. You obviously do not want to lose them.
This is a rule known to plenty of successful traders. You will not make more money if you have none. So the first objective is to preserve whatever you have. Conversely, the Martingale strategy encourages to put in the trades a large part of your funds in the hope that a future win will be big enough to earn money for you.
In the worst scenario, you will invest all that is left on your account in a single trade hoping for the best. And if it goes wrong, your account will remain empty.
The Martingale strategy on the Olymp Trade platform
The Martingale strategy can work. Nevertheless, markets are unpredictable and sensitive to news releases. The situation can change quite fast and it could mean a big loss for you. There is always a great risk in trading options with the Martingale strategy.
Hints on how to apply the Martingale strategy to trading options
The Martingale strategy is possible to apply also to trading options at Olymp Trade. But instead of throwing larger sums in every trade, you may use the following trading system.
Determine a fixed amount for one trading cycle
You do not have to risk all the money from your account. It will be enough if you predetermine a quote that you are willing to invest in a specific cycle. For instance, you may choose a total of $200 for a trading cycle.
The amount of $200 can be further divided to $50 for the first trade, $70 for the next trade and $80 for the last one. $200 invested in a trading cycle is only a fraction of all the money on your account and you use these $200 until it is depleted.
So the first tip is to determine the maximum amount you are willing to trade in one cycle. And what is a trading cycle? It is simply a fixed time frame. Like in the previous example, during a downtrend you could choose to trade three consecutive bearish candles along with the trend.
A common thing about cycles is that the probability of a reversal of the trend increases when the price enters a cycle. And you cannot predict the exact moment it will happen. That is why you should do your best and gain as big profit as you can during one cycle before the reversal of the trend.
For instance, when the price touches the levels of support or resistance, it can range, reverse or break out. You do not know the time when it is going to happen. But as you have identified the level of support/resistance, you can test the market direction with the use of the Martingale strategy.
Even if you lose small amounts in the beginning, you will later identify the direction of the market and thus increase the probability of the winning trade for a larger sum of money.
The Martingale strategy works for longer transactions
The Martingale strategy can be a good option if you are interested in staying in position for a longer time. You may wish to open 3 different positions during the day, in the morning, in the afternoon and in the evening.
In the morning you will use a small amount from your funds as it will be basically used to test the market.
In the afternoon, there is time to verify your earlier findings. If the trend is confirmed, meaning both trades won, you should trade in the evening in the same direction as during the rest of the day.
The advantages of such a system are plenty. You get enough time for the market analysis that is based on the outcome of your own trades. Then, you can use quite small amounts to test the direction of the market. All of this maximizes the odds of trading success.
The Martingale strategy is risky and I would rather not recommend it. But it has its advantages. Just you need to use it wisely and remember to have the right money management strategy. Never put a large part of your balance account on a single transaction. You need also to have some flexibility and emotions under control.
Wish you only profitable trades!
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