One method of trading that a lot of our forex traders’ use, is

holding their position for only a very short amount of time and a very small

number of pips. Essentially what they are trying to achieve is a high accuracy

edge.

A trading systems’ edge is what is going to make it profitable in the long run.

A great example of an edge is a blackjack game at a casino. Based on the rules

of the game, the house has a very slight edge over the player. After a lot of

repetition, a great sample size of hands is played and the casino exploits the

edge and makes a lot of money. This should be the same with any system. It is

critical to understand that losses will happen and the only way to win is have

an edge over the long run.

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With this in mind different systems have different types of edges. In this

article I will show you a great risk management trick called the Martingale that

will help you maximize the returns of a high accuracy system. Before I go on,

let me briefly describe what the Martingale Strategy is. Then I’ll show how it

can be used. Here’s how it works in theory:

In the Martingale Strategy you increase your position size when you have

multiple losing trades in a high accuracy system. When the system’s performance

reverts back to the mean and begins to win again, the losses are quickly

recouped because of the increased size of the winning trades.

Okay, let’s get started.

First, let’s talk about a few of the key components that a trading system or

strategy should have:

**Reward/Risk Ratio and Accuracy**

The reward/risk ratio (RRR) is the expected profit divided by the expected loss

on a particular trade. How much you are risking and how much you expect to make.

Accuracy is simply the percentage of trades that you are correct on.

Your reward/risk ratio for a particular system has to be consistent with the

accuracy (winning percentage) of a particular system. I will go into a couple of

examples below, but the bottom line is that the RRR and the Accuracy are usually

inversely correlated. In other words, the higher the RRR, the lower the accuracy

is, and vice versa.

Example:

If you are using a system that is only holding for a few pips and you are trying

to achieve high accuracy, you don’t need a high RRR at all to have positive

expectancy. For example, if your winning percentage is 90%, you can afford to

have an RRR of .5.

Using a simple example of 10 trades:

When adding advanced risk management concepts like dollar cost averaging and

pyramiding and a Martingale principle, you can enhance your expectancy further

to create some really nice results.

In this article, I will explain how to maximize the returns on a high accuracy

system by using the Martingale principle. We at forexyourself.com have numerous

proprietary trading accounts and are currently working on a high accuracy system

for forex that takes advantage of this very principle, and the system is showing

very promising results.

Before I talk any further about this principle I need to set one golden rule in

place. This is what is called the 2% Rule. According to this rule, a trader

cannot risk more than a certain percentage of his account on any single trade.

In my opinion, this is actually the holly grail to trading any instrument. Since

I am very conservative, for me the number is 2%; some traders like to go as high

as 5%. I would strongly recommend not risking more than 5%, especially on a

highly leveraged vehicle such as forex.

Essentially you have to determine position size based on this rule. The

calculation is very simple and we actually have a calculator on our website

http://www.forexyourself.com/risk-calculator.php.

Example:

Total account size: $100,000

Maximum single trade loss %: 2% {set}

Maximum single trade dollar loss: $2,000

Now you have to calculate your loss on a single contract based on the distance

from your entry to your stop and than divide it into your maximum single trade

dollar loss to obtain your maximum position size in contracts or shares.

Entry: 1.1850

Stop: 1.1830

Max $ loss per contract: 20 pips = $200

Maximum single trade dollar loss from above: $2000 (2% of $100k)

Optimal position size: $2000/$200 = 10 contracts

Now that you know how to determine the upper limit to your position size, we can

discuss the Martingale strategy.

A high accuracy system will be correct 8-9 times out of 10. The only drawback to

this is that your losses will be larger than your winners, as we discussed

above. So once you hit a loss, it will take a big bite out of your winners. What

if there was a way to recoup that loss very quickly? The Martingale strategy can

help you do just that.

First you must understand that it is not a good idea to trade near the upper

limit determined by the 2% rule when using a Martingale strategy. So if the

largest position you can take is 10 standard lots, when using a Martingale

strategy I would recommend you start with 2-3 mini lots.

Since it is statistically fairly unlikely that you will have a great deal of

losing trades in a row in a 90% accurate system, you can play with the position

size to put the odds in your favor.

Let’s say that you have an RRR of .5; you will loose $2 for every $1 that you

win.

As you accumulate your winning trades, keep the same position size (let’s say 2

mini lots). Once you hit your first loss, you can double the position on the

very next trade because since the system has high accuracy, the chances of 2

losses in a row are not very high. If the next trade does turn out to be a

loser, you double the position again. You can double up to your maximum position

size calculated by the 2% rule. Once you hit that size you should just keep that

size as you trade until you hit your next winner. However, because you are

starting out with such a small portion of your account, this is not likely to

happen.

Let me give you an example with the figures that we used above. Suppose you have

a system that is 80% accurate and has a RRR of .5, so you make $1 on your

winning trades and lose $2 on your losing trades. Let’s say your 1st and 7th

trades were losers. You are getting 10 pips on your wins and losing 20 pips on

your losses. Let’s run through the example on a 10 trade sample size:

Martingale +60 Pips

No Martingale +40 pips

You can see how the martingale enhances the system.

Now let’s look at an example with 2 loosing trades in a row and see if the

martingale helps.

Martingale +50 Pips

No Martingale +40 pips

So keeping the same accuracy, the Martingale system even works with 2 losing

trades in a row in a 10-trade sample size.

When using the Martingale strategy, I recommend keeping a few things in mind:

1. Trade very small — positions can run up a lot by doubling them so start out

very small so that you don’t get into trouble.

2. Never Exceed the 2% Rule — Never exceed your maximum single trade size no

matter what.

3. Use this only on a high-probability system.

4. Use back testing to determine your accuracy from a large enough sample size.

Using the Martingale approach can be very beneficial in increasing performance

of high probability strategies. I will discuss a few of the high probability

strategies in our seminars and further articles. This strategy must be used in

conjunction with the 2% Rule and may be use in conjunction with other risk

management principles.

**Alexander Nekritin** has a been a professional trader for over 10 years and is the Founder and President of TradersChoiceFX.com. TradersChoiceFX is a Metatrader Forex Brokerage firm that is able to enhance their clients FX trading success through their through their Forex bonus program. TradersChoiceFX also strives to set clients up with the ideal environment for their Forex strategy. You can download a free Metatrader Practice Account from TradersChoiceFX and get instant access to a special report that will teach you how to use a Forex bonus program to improve your success as an FX trader.

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