Introduction to grid trading system – Part III
The most interesting, albeit dangerous grids, are ranging grids. Markets are ranging 70% of the time. Trends end with powerful opposite movements that knock out trend followers. This is why, most of the time, a grid system would work. And in fact, if one would expect a ranging market for a while, a ranging could be used to milk some profits, but cautiously.
Of course that a ranging could be built opposite than a trending grid, with sells above the current price and buys below the current price. However, if the market starts to trend, there is not too much time to react until the damage is done. Even if the drawdown function would be similar to the drawdown of the trending grid, eventually markets get out a range and start to trend, but when a trend will turn into a range, the market will not return to the previous levels from which our ranging grid has been set up. Therefore, ranging grids will have a different approach.
One approach that could be used is bracketing, by using bricks made out of sells and buys, one atop the other.
In a desired market movement, we would want naturally to have all the brackets filled correctly. That is, from the current level, market should for instance keep going up, take the first buy and first sell, then up again, second buy and second sell, then down, with the lower first buy and lower first cell and so on.
However, since things on market go everything but by the book, most likely wouldn’t take a similar path. The brackets are close to each other. However, if the market will take a broken path, This trade setup has the advantage of a very low, crawling drawdown. Because, when the market will not do as we wish, it will have a bracket traded incompletely.
For instance, market goes down, takes the first sell, then up, takes the first buy, and then continues to go up. This way, the market will fill the brackets in an undesired fashion, that is, will create loss brackets instead of profit brackets, and the drawdown will be made by interbracket spaces:
The condition to turn this into profit, is to have the market switch direction inside an interbracket space, thus enclosing profit brackets.
Furthermore, even if the market if the grid is initiated correctly, it’s no guarantee that it will work out. Will you just stop after one bracket of profit ?
This is not the same as the trending grid. Especially if things go well, you will have the tendency to leave it on. Problem is, at some point, market will turn again, and if it leaves the terminal bracket unfinished, this single trade will eat your profit and put the system in loss:
So the market goes up and encloses brackets, but the final upward bracket will only have the buy filled. As the market starts going down, there are no other trades to hedge that buy, which creates losses freely. When the market goes below the initial level, the buy will be hedged for a while, by the first sell below the initial level, however, that will be hedged by its own buy and reserve profit, and our free trade will continue to create losses, that apply on full travelled distance, not just the interbracket spaces.
Therefore, as a conclusion, the profit probability will be tightly linked with the ratio between the bracket and interbracket space. The higher this ratio, the smaller the losses, yet the more improbable the profits.
And don’t think about intersecting this grid with another grid, displaced. Instead of one trade, there might be two trades that will be unhedged at the same time, being the same type.
But about solving this problem, check our next article in this series.