A few years ago on the Oanda forums, a frustrated trader who after beating his head unsuccessfully on trading for several years posted the following:

“Over the several years that I have traded on this platform, I have noticed some things:

1) I do not know when pairs will go up or down.

2) I do not know how long pairs will go up or go down.

3) I do not know how far pairs will go up or go down.

4) Pairs go up and down.

I can’t predict anything but #4. Maybe other people can. I can’t. I have proved that to myself. Therefore, I am trying a method which might profit from the fact that prices go up and down.

Here is what I have been doing the last 3 weeks with my very small account (because after 4 or 5 years, I still suck at this). But it has been fun.

Imagine a chart of the AUD/USD. Above and below the current price, place small limit buy orders at 15 pip increments (05, 20, 35, 50, 65, 80, 95). The take-profit is set for 15 pips on each limit buy order. Reset each order that takes profit.

Flipside. Imagine the chart of the EUR/USD. Above and below the current price, place small limit sell orders at 15 pip increments (05, 20, 35, 50, 65, 80, 95). The take-profit is set for 15 pips on each limit sell order. Reset each order that takes profit.

Now imagine for the moment, just the AUD/USD chart with all those little buy limit orders. If price climb steadily up, you are buying and cashing in every 15 pips. If price is choppy, you are collecting on dips and selling on peaks. However, if price steadily declines, you are accumulating positions and drawing down margin.

The EUR/USD sells are a kind of hedge, taking profits on the reverse moves. I do these two pairs because of the small spread and they often move together. I happen to do the AUD/USD long, since it gains interest. Keep the limit orders small. Occasionally liquidate position and reset orders above and below market.

Tripled the account in 3 weeks. I know that the alarm bells are going off in folks heads, because big gains could indicate disaster down the road. But we’re just talking dinner money.”

With the lure of not needing to be able to pick the direction of the market and tripling your account in a matter of weeks this one post created quite a large following on the Oanda forums and even spilled over into a number of other forums as a number of traders started to report that they were able to reproduce the outcome.

The first time I read the threads devoted to grid trading it made no sense to me as it is doing exactly opposite to what most trading books teach. Instead of cutting your losses and letting your profits run, this system does the opposite, it takes profits quickly and holds on to loosing positions. The problem with holding on to loosing positions is you start accumulating draw down real quick if you get the direction of the market wrong.

If you follow the threads devoted to Grid Trading on the Oanda forums, you start noticing that a number of traders have blown their accounts up. It seems that what seems to happen with Grid Trading is you are inevitably left with “hanging positions”. The price moves to a high point on the grid and you open a number of positions and then the price rapidly retreats two, three, four or even five hundred pips and the trader is left with a number of under water open positions that are rapidly building up a rather painful draw down.

Some of the less experienced traders could not handle the psychology of the draw down. When the draw down got too high for them they pulled the pin on the trades and took an actual loss, which wiped out weeks of work grinding out a profit grid trading.

The more experienced traders had a sense where the price was likely to revert to over the longer term and just held tight letting the draw down accumulate knowing that they would eventually recover their positions if they were lucky.

Even having the experience to do this was not enough for some traders and they still wiped out their profits. Some of the more experienced traders went one step further and tried to fix the grid trading approach by adding several twists. Some traders experimented with different spacings in their grids depending on how far the price was away from the median price and also with disaster stops. For example, they would look for a likely top and bottom of the grid based on their sense of where the price was likely to head over the next few weeks. They would then place disaster stops just below the bottom of the grid and then towards the top of the grid they would space the grid out much further apart so that you are less likely to be left holding a “hanging position”. Some traders even looked as far putting counter weight “box options” at the base of their grids to make up for the loss.

Next Article

In my next article I will go through Dirk Du Toit’s 4×1 method for discretionary grid trading.

This entry was posted on Thursday, March 20th, 2008 at 11:47 pm and is filed under Grid Trading. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.