A grid trading system is the multiple buying and/or selling of the currency at predetermined levels/intervals of the market without stop loss. A grid system can come in two flavors:
- Pure Grid Trading: buy and sell limits are set are within a predefined market range, regardless of market direction;
- Modified Grid Reading: the grid mechanism acts as a trade management component of directional entry system.
Both systems have the appeal of working very well in sideways markets (80% of market activity) and slowly trending markets. You don’t ever get stopped out and your balance (and, for a time, your equity) can climb through the roof. However, both the pure and hybrid grids are not immune to problems: a pure grid can blow up in strongly trending markets, and the modified grid can pile up damage when it finds itself on the wrong side of a strong trend reversal. We will look at each of these systems in more detail.
Pure Grid Trading: Beautiful in a range, Deadly in a Trend
The Pure Grid Trading System does not care about the market direction for it places its buy and sell limits, each with specific target prices, at regularly spaced intervals above and below the current market price. Pure grid advocates and systems attempt to locate a market stuck in a range, and they then grid that range, placing buy (long) trades at the bottom half of the range and sell (short) trades at the top half of the range, spreading the leg intervals and target profits equal distance from each other along the entire range.
It works on the premise that it is the range that is gridded will hold intact and that it is the nature of the market to trade sideways 80% of the time and to trend 20% of the time. If market is trading sideways, then both buy and sell limits are being repeatedly executed and attendant profit targets are being hit. Even when markets trend 20% of the time, grid proponents argue, there is enough vacillation within the trend to knock out repeat profits.
Let us look at an example of a former, long-time successful grid robot called Robominer that worked on EUR/CHF and AUD/NZD. The below description is the system in a nutshell and it worked well for some time.
According to its own literature, “the pairs selected for grid trading exhibit relatively narrow historical trading ranges – in each case, a total range of about 2640 pips. This 2640 pip range is divided into 66 sub-ranges, corresponding to the size of an average wave in each pair. Above the center point of the range, Robominer opens only sell (short) trades, and below the center, it opens only buy (long) trades. If the pair remains within its 2640 pip historical range, no more than 33 trades can remain open at a loss, creating a drawdown on the account balance. (No trade will be closed until it is 40 pips in profit). The total accumulated drawdown for AUDNZD would then be $1525 ($2319 for EURCHF). As long as the account balance cover this potential drawdown (plus an extra margin of safety), the likelihood of a margin call and loss of funds is kept to a manageable minimum.”
(at least in 10 years of backtesting and for the last couple years up until February 2010).
EUR/CHF was indeed stuck in a 2500 pip range from 1994 until recently, as you can see from the monthly chart below (range high is approximately 1.7000 and range low is approximately 1.4500).
Robominer was designed to sell short every 40 pip interval at the top of this range, and buy long every 40 pip interval at the bottom. Profit targets were set every 40 pips from entry. Since it was designed some time in 2008, it faired extremely well in the 10-year backtesting report, and very well in forward testing for 2 more additional years up till February, 2010. Then tragedy befell the system. The EUR/CHF pair dipped down to the 20-year support of 1.4500, and the support failed to hold as it had in the past: the pair nose-dived 1500 additional pips from the broken support line. All Robominer EUR/CHF users were decimated as their 33 open trades had to take on 1000+ pip open position losses.
Robominer’s tragedy represents the fate of all pure grid systems: no matter how well a range is plotted and defined and chopped into its pip intervals and profit targets, the range will never always hold. Sooner or later the trend becomes fierce enough to break the range, and the numerous open positions on the wrong side of the breakout add up their pip loss agony to bust the account.
Advantages (or Appeals) of Pure Grid System:
- It is simple to use. Even without an EA, a manual trader can plot and manage a grid with relative ease.
- It is free of constant inter-market analysis of which direction to take. No need to worry about getting the direction wrong (at least when market stays within the larger range). So long as the larger range holds, one can cash in a positive deal no matter which direction (or indirection) the market moves.
- It is Stop Loss independent. No need to worry about stops being hit. Stops are often too big and other times too small. Many times traders are in the right direction of the trade only to be stopped out prematurely from too small a stop loss. Other times stops are so big that when they are hit they wipe out all the previous gains.
- It is profit timing independent. No need to worry about getting out at the right time. Often traders set a profit target for 50+ pips only to see the market shoot past that for another 100+ pips. Other times the market gets close to a target price only to violently reverse. With a pure grid, one can cash out at different intervals without the worry of timing the exit.
Disadvantages of a Pure Grid System:
- If you do not plot the range and intervals wisely, it can blow up your account very fast. For instance, most beginning grid traders select the last most visible range on a daily chart and then select very small grid leg sizes e.g. 20 to 30 pips. This is a recipe for quick disaster.
- Inherently dangerous. Even if you plot the range and intervals with the most exacting of mathematics and historical record, the range will eventually be broken and your account will eventually blow up. Robominer looked at the 20 year/2500 pip range of EUR/CHF and tried to plot that with precision, but eventually, that range broke and ended in disaster.
- Mounting negative overnight interest. You need to use currencies that have a low or positive night interest because gridded positions can be open for a long time, and negative overnight interest can mount up.
Modified Grid Trading System
Unlike the Pure Grid Trading System, the Modified Grid Trading System cares about the market direction prior to sprouting its grid legs in support of it. The system first determines its initial entry from indicators that attempt to gauge market direction and strength. It follows through with its confidence or bias in the trend by gridding the entry with a number of equal-sized buy limit orders evenly spaced underneath the initial buy, or a number of equal-sized sell limit orders evenly spaced above the initial sell.
The idea behind the hybrid grid system is that its determination of market direction is ultimately right, and it is more preferable to grid the other side and enter in at better position levels than it is to have a small stop loss that prematurely exits you from the trade. The hybrid grid can have a few grid legs or many. The profit exit of the hybrid grid can be a percentage, pip level or dollar amount of the total trade (including both its initial and gridded positions). The downside exit can be non-existent (no stops of any kind), or there can be a large stop loss (in percentage, pips, dollars) of the total trade in case of emergency.
Advantages (or Appeals) of a Modified Grid System:
- The trend is your friend. It avoids the major pitfall of the pure grid system in that the larger trend can be your friend instead of your enemy. You will keep entering and exiting with repeat profit if market retains its trend direction.
- The range and sideways market are also your friends. If the market enters in a range or chops sideways you can average into the position better, you will be out with some profit, and your system will wait again for next trend direction to make its appearance.
- It can be Stop Loss independent—and thus never see many small losses that eat away the account.
- It is profit timing independent. No need to worry about getting out at the right time. If the market goes up from your initial trade, you make money; if the market falls against your initial trade, you can scale into better positions to make your money later.
Disadvantages of a Modified Grid System:
- Highly dependent on the accuracy of its initial entry setup for trend direction. If your system identifies the wrong trend direction at the wrong time, such as at the end of a trend (start of a trend reversal), the counter-trend trade can be fierce enough to blow through all the trade intervals and add up the damage.
- Dependent on the proper calculation of the interval width. If the intervals are too narrow, trades and losses can mount up too quickly; and if too wide, trades cannot offset each other fast enough in case of a trend reversal when you ultimately want to be out of the trading scenario.
- No stop can be deadly. Having no stop loss in place can be problematic because a counter-trend move might be fierce enough to destroy your account. Having a large stop loss protection in place can also be a detriment because it will be hit more often than not, and each time it is, it will eat up weeks of profits.
In the final analysis, the modified grid has much more going for it than the pure grid system. It can profit from sustained trends instead of being punished by them. It can adapt at moving around in channel and whipsaw conditions. The calculation of the entry, the intervals and exits need to be correct in order to get you in and out at the right place. The grid has to be smart enough to avoid a fierce reversal or “double down” to breakeven before the reversal has time to pick up momentum.
The Achilles Heel of the best of modified grids is a fierce market reversal that breaches all grid levels. With no stops in place, the market can explode away from you with the grids adding to your liability and losses. Because a fierce and unexpected market event is always lurking around the corner, you should be trading the modified grid with the lowest possible leverage and lot size.