If you lose money in the stock market, do you double down? That’s called a martingale strategy, and it’s dangerous

You buy a handful of dividend stocks, promise to stay disciplined, then markets sag. The itch to “buy the dip” wins, so you find more money to invest.

A quick rebound follows, and your account shows a double-digit short-term gain. It feels like skill, yet nothing magical happened. You simply took a bigger risk the moment prices went against you.

Behavioural finance researchers have a term for that: a martingale strategy. A new study published in the Judgment and Decision Making journal quantifies how much of any apparent edge comes from adding money after losses rather than from superior insight.

The authors’ Martingale Index is essentially a self-deception gauge. The higher it is, the more your success depends on ever-larger bets – and the closer you drift toward a blow-up.

Increase your invested capital when the market is down, and a modest rebound suddenly translates into a handsome percentage gain on the newest cash. But real improvement in investment-picking skill is an illusion that arises because the denominator has swelled.

For traders, if the slump deepens, they need to contemplate whether they will inject even more money hoping for a reversal, borrow to invest with leverage if they are out of cash, sell other investments in order to double down, accept a larger loss or just hold on.

No matter which path they choose, emotions and the stakes are higher now. Not a great combination.

Casinos are no strangers to this phenomenon. A roulette betting strategy known as the “d’Alembert” has players raise the next wager by one chip after a loss and reduce it by one after a win.

Although this system can string together plenty of small wins, the paper’s authors point out that any gambler with finite capital is almost bound to blow up eventually. Sooner or later, the rising bet sizes run into a bad streak or table limit.

The Martingale Index for that strategy is enormous because nearly all the apparent success is purchased with bigger wagers rather than “smarter guesses” about whether red or black will hit next.

Translate the same habit to capital markets and the mirage follows. Here, the table limit is equivalent to running out of access to capital, leverage or resolve.

The researchers model a retail investor who adds extra margin only after losing days and posts an average 15-per-cent gain in a typical three-month stretch.

But the increased risk of this strategy may not be fully appreciated by investors. Risk-adjusted returns did not improve. And the chance of a blow-up that may be difficult to recover from increases.

It can look like dollar-cost averaging, but that’s not accurate. True dollar-cost averaging refers to taking a lump sum and dripping it into the market over time in equal instalments.

Regular payroll or monthly contributions, often called systematic investing, likewise follow a preset schedule regardless of market moves. In both cases, the total exposure grows at a steady pace.

A martingale strategy is different because it boosts the stake specifically after a drop, so the extra performance comes bundled with extra, uneven risk. Lower prices can improve the expected return on each new dollar invested, but adding more dollars after every dip still enlarges your overall stake, so any further slide slices a bigger chunk from your wealth even while valuations look better.

There is, however, a sensible middle ground. Redirecting truly spare cash into a broadly diversified, long-term portfolio when prices are lower can be reasonable because the money is spread across thousands of companies and you can walk away from it for years.

Doubling down on a single stock after it tumbles is a different beast because one company’s fate can quickly swamp the rest of your plan.

The sturdier path for most investors remains simple: Pick a diversified, low-fee portfolio, automate contributions and let time rather than wager size do the heavy lifting.

Market history shows broad portfolios rise more than they fall. Focusing primarily on a fixed saving plan captures that upward drift. Liquidity stays intact, emergency funds remain untouched, and no line of credit becomes collateral damage in a prolonged downturn.

Bigger bets can make anyone look brilliant for a season, but the Martingale Index reminds us that flashier numbers are often just payment for taking greater risks.

The smart play is still the boring one: own the market, invest on a schedule and keep casino tactics far from your retirement savings.

Preet Banerjee is a consultant to the wealth management industry with a focus on commercial applications of behavioural finance research.