Thursday, October 22, 2009

Greed Trading Towards a Wipeout... A Review about Grid Trading Systems

From the many different trading strategies that have emerged during the past 5 years, few of them have caught so much attention as grid trading. This trading strategy appeared first as a trader's post within an Oanda trading forum, a post in which he suggested the use of a "trading grid" as a way to capture profits from market movements. That is, grid trading established a "grid" around the current price from which trades are opened and profits are taken. While price oscillates within the grid, the trader obtains a very large amount of profit since a lot of money is taken from the successive moves of price over the grid. As it is shown in the next scheme, grid trading opens positions towards the center of the grid and captures profits as returns to the median price happen.

+ etc
+4x pips (open short)
+3x pips (open short)
+2x pips (open short)
+1x pips (open short)
-- Median price level --
-1x pips (open long)
-2x pips (open long)
-3x pips (open long)
-4x pips (open long)
- etc

Any experienced trader will easily recognize the most important flaw of grid trading. In the most pure state of grid trading, no stops are used since price is assumed to return to its median value after a given period of time. The result of this assumption is that there is an uncapped market exposure towards price movement. Grid systems will work great while the market behaves in a consolidation fashion because prices will perfectly follow mean reversion theory but when the markets needs to readjust to changing economical conditions as currency values change, the story is different.

As you can imagine, grid trading will always accumulate loses towards the movement of a trend since it will always assume that there will be a return towards the previous price levels. In fact, grid trading is doing what any seasoned trader would consider ridiculuos, it is limiting profits and letting loses run. On top of that, it is adding positions constantly against the trend, something which is absolutely prohibited by almost all the currency trading books I have read.

Grid trading, as Martingales and all other strategies that generate short term profits has gained a lot of attention from people and it will, as do martingales, draw more attention in the future. All the time new traders will find grid systems, trade them for four months for a 10x profit and then hype their account only to restart the cycle with more people who think they can make grid systems profitable. If you also believe that you can just "withdraw profits" please check my review of forex hacked for an explanation of why this strategy causes even more loses in the long run in both Martingale and grid trading systems.

As I have said, it is nonsense to try to trade a grid system, they are faulted by the nature of their very logic. It has shown to be the case that no grid trading system can be long term profitable. Mainly because of the fact that currencies never hold onto their ranges eternally, all currencies having ranges, be these ranges short or long term, will eventually break these ranges and trend far more than what people would expect. If your market exposure is unlimited, the market will cash on that and wipe your trading account with time. Regardless of the hundreds of modifications of grid trading that have been tried, the facts remain the same, unlimited market exposure equals account wipe outs.

For anyone looking into trading these type of systems I would advice you look for long term profitable systems instead. This systems are often simple trend following systems with adaptative money management that profit from reliable long market moves. If you would like to learn more about what I have learned from automated trading systems and how you too can trade them, program them and profit from them with realistic profit and risk expectations please consider buying my ebook on automated trading or subscribing to my weekly newsletter to receive updates and check the live and demo accounts I am running with several expert advisors. I hope you enjoyed the article !

1 comment:

Maxim said...

Thanks a lot for clarifying what the grid trading system is!

Maxim

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