Gambling & Day Trading – Theory of Runs

Not many people would think that a theory developed for roulette and other similar gambling games could lead to a strategy for managing money in the markets – but the “Theory of Runs” does just that. The theory of runs is the theory that can link gambling and money management together.

The theory of runs is a theory that can be applied to high-leveraged or short-term trading, which is part of the reason that many traders will try to use it in the Forex market – since the Forex market works with high-leveraged and short-term trading.

To give you an idea of the theory of runs, think of a roulette wheel. On a spin there is a 1 in 2 chance, or 1/2, that the ball will be either black or red. So in theory, there’s also 1/4 chance that there will be two black in a row or two red in a row, and the odds get smaller and smaller as you continue.

The theory of runs assumes that if the pick comes up red four times, then the chances are far greater than 1/2 that the ball will come up black on the next roll. Since there is only a 1/32 chance that the ball will go red five times in a row, the theory is that if the ball has already gone four times in a row, that somehow that fifth spin due to the law of averages if far more likely to go the other color than the basic 1/2.

Sports bettors will sometimes use this to explain why there will always be a “bad week” to average things out even after doing all the research on their picks.

The same example can be used with flipping a coin. If I flip a coin five times in a row, the chances of it landing heads on the sixth (in theory) are 1/2, but if the coin was heads all five times before that (a 1/32 chance), then the theory of runs is that the coin must become more and more likely to land tails with each flip.

Any time the “theory of runs” is being applied, it relies on 2 major conditions:

1. There is NO statistical advantage in occurrence of profits and losses

2. Theories must stress money management under adverse conditions

In the Forex market, Martingale and Anti-Martingale trading methods take this theory of runs into account. A martingale method suggests that the initial bet should be doubled each time a loss occurs, because after a win the better gets back to even, and then bets at the original investment once again. DO NOT USE THIS FOR TRADING THE FOREX!

An Anti-Martingale method is the exact opposite. Winners are doubled until a preconceived goal is reach, and then after that run is reached, you stop immediately and withdraw your money before the streak ends. Or, you keep adding more money until you have a loss.

These methods of trading Forex are directly related to the theory of runs, and are methods for trading the market. Each has its strengths and weaknesses, though many traders prefer a proven system that isn’t based on gambling theory.

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