Educational: Grid Trading, What is it? How it works?
Grid trading is often marketed as a way to win every trade. People usually get away with this type of marketing of the trading style due to the fact that grid trading does not care for market execution in the sense of market direction because you will close profitable trades if the market goes up or down. But it's not as simple as that.
What is Grid trading?
Grid trading is a type of trading strategy that makes use of market price variations by placing buy and sell orders at regular intervals around a base price. The foreign exchange market is where grid trading is most frequently employed, but it can also be used on other markets, like those for futures contracts.
How to execute trades on a grid
The image above explains exactly how positions that run in the upper direction are executed. Let's break down the process:
(1) At the start of your grid trading system, you execute a buy and a sell position with the same lot size.
(2) You will only set a take profit and a buy limit/sell limit, but no stop loss.
(3) Assuming the price runs in the direction of the buy and you have a 10-pip stop loss, once the price hits your 10-pip stop loss, you will also execute a sell position via the sell limit. This sell position will have a 10-pip take profit in the opposite direction.
See demonstration below:
There is no restriction on the size of the grid. It does not have to be 10 pips apart. The distance of the grid is explained further in the publication.
Here is a video using a trading simulator to show you how these positions would be executed
:
So, as you can see, with this style of trading, you can potentially make money whether the price goes up or down. However, it can be quite challenging to execute and maintain a large number of trades. Therefore, individuals typically employ automated systems or use trading software to manage and monitor these trades.
Trending Market
Grid trading can be used to profit from both trending and ranging markets. In a trending market, grid trading involves placing buy orders above the base price and sell orders below the base price. This way, the trader can capitalize on the price movement in a sustained direction. For example, if the base price of Bitcoin futures is $60,000, the trader can place buy orders every $1,000 above the base price. This is also sometimes wrong referred to as dollar cost averaging or compounding your trade which are very different investment strategies.
Grid trading's key benefit is that it can be readily automated using trading bots and does not require a lot of forecasting of market direction. Grid trading's main disadvantage is that, if the market goes against the grid and the trader does not apply appropriate risk management strategies like stop-loss limits or position sizing, it may result in significant losses.
Grid Size
Choosing a grid spacing is one of the most important aspects of grid trading. This depends on a number of elements, including:
- The volatility of the market: The more volatile the market is, the wider the grids should be to avoid frequent executions and commissions.
- The personal preference of the trader: The trader should choose a grid size that suits their trading style and risk tolerance.
Technical indicators like moving averages or Bollinger bands are sometimes used to calculate the spacing between the grids. These indicators can be used to determine the market's volatility and average price over a specific time frame. You can also use basic price action to determine what range the market is likely to tstay within and then calculate the grid in-between
Ranging or Trending:
Identifying whether the market is trending or range is another important aspect of grid trading. This can be used to determine whether to employ grids that move with the trend or against it. There are a number of approaches to determine if the market is trending or fluctuating, including:
- Using trend lines or channels: A trend line or channel is a line that connects higher highs or lower lows in a trending market. A break of a trend line or channel can indicate a change in trend or a range-bound market.
- Using trend indicators such as ADX or MACD: The average directional index (ADX) measures the strength of a trend on a scale from 0 to 100. A high ADX value (above 25) indicates a strong trend while a low ADX value (below 20) indicates a weak trend or a range-bound market. The moving average convergence divergence (MACD) measures the difference between two moving averages of different lengths. A positive MACD value indicates an uptrend while a negative MACD value indicates a downtrend. A crossover of MACD lines or zero line can indicate a change in trend or a range-bound market.
Link to a publication on MACD :
- Using range indicators such as RSI or Stochastic: The relative strength index (RSI) measures how overbought or oversold a market is on a scale from 0 to 100. A high RSI value (above 70) indicates an overbought market while a low RSI value (below 30) indicates an oversold market. A reversal of RSI from extreme levels can indicate a change in trend or a range-bound market. Link to related publication:
What is Grid trading?
How to execute trades on a grid
(1) At the start of your grid trading system, you execute a buy and a sell position with the same lot size.
(2) You will only set a take profit and a buy limit/sell limit, but no stop loss.
(3) Assuming the price runs in the direction of the buy and you have a 10-pip stop loss, once the price hits your 10-pip stop loss, you will also execute a sell position via the sell limit. This sell position will have a 10-pip take profit in the opposite direction.
See demonstration below:
There is no restriction on the size of the grid. It does not have to be 10 pips apart. The distance of the grid is explained further in the publication.
Here is a video using a trading simulator to show you how these positions would be executed
:
So, as you can see, with this style of trading, you can potentially make money whether the price goes up or down. However, it can be quite challenging to execute and maintain a large number of trades. Therefore, individuals typically employ automated systems or use trading software to manage and monitor these trades.
Trending Market
Grid trading can be used to profit from both trending and ranging markets. In a trending market, grid trading involves placing buy orders above the base price and sell orders below the base price. This way, the trader can capitalize on the price movement in a sustained direction. For example, if the base price of Bitcoin futures is $60,000, the trader can place buy orders every $1,000 above the base price. This is also sometimes wrong referred to as dollar cost averaging or compounding your trade which are very different investment strategies.
Grid trading's key benefit is that it can be readily automated using trading bots and does not require a lot of forecasting of market direction. Grid trading's main disadvantage is that, if the market goes against the grid and the trader does not apply appropriate risk management strategies like stop-loss limits or position sizing, it may result in significant losses.
Grid Size
Choosing a grid spacing is one of the most important aspects of grid trading. This depends on a number of elements, including:
- The volatility of the market: The more volatile the market is, the wider the grids should be to avoid frequent executions and commissions.
- The personal preference of the trader: The trader should choose a grid size that suits their trading style and risk tolerance.
Technical indicators like moving averages or Bollinger bands are sometimes used to calculate the spacing between the grids. These indicators can be used to determine the market's volatility and average price over a specific time frame. You can also use basic price action to determine what range the market is likely to tstay within and then calculate the grid in-between
Ranging or Trending:
Identifying whether the market is trending or range is another important aspect of grid trading. This can be used to determine whether to employ grids that move with the trend or against it. There are a number of approaches to determine if the market is trending or fluctuating, including:
- Using trend lines or channels: A trend line or channel is a line that connects higher highs or lower lows in a trending market. A break of a trend line or channel can indicate a change in trend or a range-bound market.
- Using trend indicators such as ADX or MACD: The average directional index (ADX) measures the strength of a trend on a scale from 0 to 100. A high ADX value (above 25) indicates a strong trend while a low ADX value (below 20) indicates a weak trend or a range-bound market. The moving average convergence divergence (MACD) measures the difference between two moving averages of different lengths. A positive MACD value indicates an uptrend while a negative MACD value indicates a downtrend. A crossover of MACD lines or zero line can indicate a change in trend or a range-bound market.
Link to a publication on MACD :
- Using range indicators such as RSI or Stochastic: The relative strength index (RSI) measures how overbought or oversold a market is on a scale from 0 to 100. A high RSI value (above 70) indicates an overbought market while a low RSI value (below 30) indicates an oversold market. A reversal of RSI from extreme levels can indicate a change in trend or a range-bound market. Link to related publication:
C Nicholas Downie
