Dollar cost averaging by investing monthly in a low-cost index fund in one of the larger economies in the world is touted as a great passive strategy for everyone that believes in evolution. But since the premises is that the value of the index will raise over time, why not apply the Martingale strategy to improve the outcome of this long-term investment?

The Martingale strategy was introduced by French mathematician Paul Pierre Levy and relies on the theory of mean reversion. It’s simple: you double up on losing bets and reduce winning bets by half.

If you invest monthly $100 in the SPY, you could apply the Martingale Strategy as follows. In January you invest $100. If the index goes up, then you invest $50 in February. If the index goes down you invest $200 in February, and so forth. Since human nature drives most people to live paycheck to paycheck, this strategy becomes very difficult let’s say after five declining months when you should have invested 100+200+400+800+1600 = $3100 instead of 5 x 100= $500.

Even though the Martingale strategy is perhaps not applicable based on the above reasoning, we should consider utilizing it’s core idea, which is mean reversion. We can choose assets or securities that are known to exhibit mean-reverting tendencies. Stocks, exchange-traded funds (ETFs), and currency pairs with a history of oscillating around a well-defined mean are good candidates. These assets often have clear support and resistance levels. We can calculate the mean or average price for the selected asset. This could be a simple moving average (SMA) or an exponential moving average (EMA), depending on our preference and the asset’s characteristics. The mean can serve as a reference point for identifying deviations. We can consider entering a trade when the asset’s price is significantly below the mean and exiting when it moves back towards or crosses the mean. Likewise, we can consider shorting when the price is significantly above the mean and exiting when it moves back down.

In the end, the Martingale system is perhaps more suitable for FX trading (think stubborn currency pairs) as a simple multiple-entry strategy.