Introduction to grid trading system – Part I
I decided for this article to dwelve into the most mysterious grid trading systems. Grid trading systems are less known, because their application is stranger compared to regular trading systems. Most of them will be indicatorless, therefore not relying on information from the market under the form of indicator data, rather they attempt to capitalize on statistical properties of the market which are disregarding the time factor.
Grids have two modes of being conceived: as trending grids, or as ranging grids. Attempts to combine both ways will most likely result in a failure.
Normal grids are trending grids. That is, they are designed to take advantage of trending markets, while showing drawdowns during ranging markets. That is, the trader switches the perspective, from directional, to a rather volatility oriented system. Instead of betting that the market goes up or down, the trader will bet that the market will trend to one of the directions, without being important to which of them. However, opposite to a discretionary or even automated system, this ranging system will not take advantage of a movement until it ends. Grid trading systems have a fixed, overall profit target ; and it’s recommended that the target to be smaller than the range between two trades. When this target is reached, the trades are closed and the system restarts. The more the market goes up or down straight, not jumpy or with up/down spikes, the better for the system, that can make more from the movement. Such a grid can be simply designed. From the current price, one would build a grid by inserting trades that would have the same step, in pips, between them. Buy upon buy on the upper side, sell upon sell on the lower side.
Should the market begin to trend, the system will take more trades on one side. Buy after buy, for instance, will reach the target, and then reset.
However, if the market is ranging, the system will take trades on both sides. As the market goes deeper down, then returning and going higher than the previous high since the system was started, thus when the market is amplifying its range movement, the system will start to accumulate drawdowns on a progressive pattern. That is, 1 range between first buy and first sell, then adding 3 ranges between second buy and second sell, then adding 5 ranges between third buy and third sell and so on.
Not only that the system is accumulating drawdowns like this. There is a perverse effect of the drawdowns, and that is, it requires more movement on one side to reach the target profit. If you would need just about two ranges when you start the system, and it starts without trades, the system will need more and more movement on a single side to counter the losses, becoming less probable that the market will give this to the trader. To make it worse, while it builds up on a side, a change in direction is more dangerous than before, because those new trades that were taken recently are farther than the entry point, thus creating more loss to their hedging counterparts on the other side. Such a phenomena is called gridlocking.
While gridlocked, the system has accumulated a large, fluctuating drawdown. But if one places wisely the trades, with proper money management, even gridlocked systems will work, but they will take the hell of a time to get out of the gridlock state. Markets eventually breach one of the directions violently (it may take weeks or months).