Chapter 5 Grid Trading
Grid trading is when orders are placed above and below a set price, creating a grid of orders at incrementally increasing and decreasing prices. Grid trading is most commonly associated with the foreign exchange market.
Grid trading can be very risky because of "dangling trades." A dangling trade occurs when one of your orders is hit and price reverses before reaching your take profit. The further the price moves from your entry, the higher your loss on that trade. One large loss from a dangling trade can wipe out a high number of gains from your winning trades.
The trading strategy on this graph is mapped out to have three levels (three above the current market price and three mirrored below). The current market price is 1.1350, and the trader has decided to place levels at legs one one-hundredth of a dollar apart.
The appeal of this type of trading is that the model requires almost no forecasting of the market direction. However, it comes at a cost of complicated money management, trading psychology and grid visualization issues you will need to deal with.
To construct a grid there are several steps to follow:
● Choose an interval, such as 10 pips, 50 pips, or 100 pips, for example.
● Determine the starting price for the grid.
● Determine whether the grid will be with-the-trend or against-the-trend.
4 possible grid strategy outcomes
The effectiveness of your grid strategy depends in part on the way that price moves. In a trending market, price will inevitably break out of its current support and resistance band and move in one direction for a sustained period. In an ideal scenario, price would climb or fall consistently in one direction without oscillation, hitting all your stop orders and take-profit values in consecutive order.
The next two images show an ideal uptrend and downtrend breakout scenario.
There are two other possible, imperfect scenarios that might occur in a trending market:
Price might break out in one direction and then reverse to the other side, leaving a position open in the opposite direction.
Price could oscillate in a way that opens a position but initially misses your take-profit point, subjecting you to greater losses.
Pros of grid trading
● Systematic way to make profits under typical market conditions
● It doesn’t rely on strong trends. Grid trading can generate profits in trendless, predominantly sideways markets.
● Using multiple entry/exit levels means you’re less likely to be “taken out” by price spikes, market noise or abnormally wide spreads. Multiple entry points allow you to benefit from cost averaging.
● It doesn’t rely on a single “absolute view” of the market direction.
● It’s relatively easy to code software (e.g. an expert advisor) to execute and manage the order flow.
Cons of grid trading
● In order to realize profits quickly, traders are often tempted to cash in their winners too early. But losing trades are erroneously left to ride out with deep drawdown until retracement occurs.
● Some or all of the positions may end up in negative territory for a long time, so locking up capital.
● In fast moving markets your trade orders may execute far away from your desired grid levels. This can leave you un-hedged.
● Technical issues: For the grid system to work properly, it’s critically important that your orders, stops and limits execute correctly. If some of your trade orders fail you can find yourself sitting on accumulating losses.
The grid trading suggests a scrupulous analysis with the long-term view. At the same time, it allows forex traders to automate the trading process in case if the trend is gradual and sustainable, which would lead to increased profits with a balanced profit/loss ratio. At the same time, traders should maintain the money management rules, forecasting several scenarios and keeping a reasonable number of postponed orders and augments.
The grid trading system is not recommended for all traders as it requires quite a bit of practice and can turn out to be risky if the trader does not understand how to use the grid.
