I am quite excited to tell you all about Grid Trading. It is something I discovered in my research a couple of months ago and it really grasped my attention. So, what is it?
Essentially in its most basic form, Grid Trading is a reversion strategy where trades are entered as the price reaches particular pre-defined prices. So for example, every 100 pips you would enter a trade. When the market reverses your trades will eventually go into profit. It’s that simple.
The following diagram illustrates the concept on a directional grid. Just assuming round numbers for price, we enter a position every 1-unit of price.
So at every square, we enter a new sell trade. You can see that when the market reverses later those trades would go into profit and we can close them at our profit target (which may be for example 1 unit of price).
While this is very cool, I think its weakness is immediately obvious. This only works in a ranging market – but hey, that is not really any different from any other reversion strategies. Well, there is one more difference that is the both the key and failure to this strategy’s success: you hang on to losing trades until they turn profit.
So again, if you refer to the picture above, you can see the third sell trade at the bottom of the first trough would end up having a position of minus 6 units even though the profit target is only 1 unit. Even worse, losses would be compounded because all of the trades accumulate losses.
So, we would have a -6 position, and a -5 position, and a -4 position, etc until the market reverses. That is going to tie up huge amounts of capital… especially if the market never reverses back to the starting level.
This is where the fun starts of course. We have a strategy idea with a weakness, as always, and now we can research how to improve this strategy. Now there are many different ways we can improve this strategy, and essentially many different ways to perform “Grid Trading”. Some examples are below…
A hedged grid would open positions in both directions, limiting losses and locking in some profits even as the price trends. The beautiful thing about this is, you don’t need to know which way the price will go and you still have winning trades! (Just a side note: Due to hedging restrictions in the US, the only way to achieve this would be to open two accounts, one specifically for buys and one specifically for sells).
A martingale approach would attempt to average losses across the grid, hopefully delaying losses until the market does reverse.
A directional martingale hedged approach may choose to increase bet size in the direction of the trend so when the price does trend, you can offset your losses.
Another way to “Grid Trade” is to choose to treat the entire grid as a single trade instead of letting the grid run forever carrying loss trades. For example, set take profit and stop loss limits on the entire grid, and when either are reached you close all trades down and start again. This kind of approach could be ideal for when the market is usually quiet, like Mondays.
So as you can see, what starts off as a rather simple idea offers a lot of different combinations and there is a lot to look into – so exciting! Of course we are aiming to make lots of money, and under the right conditions, it certainly can make a lot of money.
The back-testing results above of my currently in-progress strategy makes 10% in 4 months on EURGBP. That is certainly something worth looking into… Stay tuned…