In this article, you’ll learn about a trading technique that embraces the randomness of cryptocurrency prices, does not require any guesses about the market’s direction and profits from fluctuations when there’s a strong trend or when the price is moving sideways.
Grid trading is a technique utilized by institutional traders that seeks to capitalize on ranging or trending markets by placing limit orders or stop limit orders at fixed intervals. There are many different approaches to grid trading but the general idea behind it is that in cyclical markets, we can trade in a way where we don’t have to care about the entry price and just slowly build a position to scale into a long or short.
One approach is to work against the trend by buying an asset at a low price and selling at a high price, which does not require you to take on a directional view of the market. With no requirement to predict where the price will go next, you can focus on managing the positions and figuring out where to exit with a profit.
For example, if the current price of ETH-USD is $1900, one strategy involves placing limit buy orders at $50 increments below the current price and limit sell orders at $50 increments above the current price. When the price falls, one or more of the buy orders are triggered and the trader ends up with a long position. A trader using a grid system to build a long position will bring their overall cost of entry down as the market moves lower.
Once the price eventually rises, the sell orders will be executed and closes the long positions at a profit. If the price fluctuates within a certain range, then both the buy and sell orders will be triggered and the grid trading strategy is more likely to be profitable.
By enabling traders to average out their entry price, grid trading strategy has much less risk as compared to going all in at the same time while also reducing the pressure to get the perfect entry. By embracing the fact that we don’t know where the price will go, a grid trading system can help you to avoid getting stopped out and prevent you from racking up losses when there are fakeouts.
The main components of a grid trading strategy include:
Market: which asset you want to trade.
Lower bound: set the minimum price level for the grid, based on the market’s price range or volatility.
Upper bound: setting the maximum price level for the grid, based on the market’s price range or volatility.
Grid number: the number of orders in the grid, which determine the gap between the buy and sell orders that are used to scale into positions.
Position sizing: the size of the position for each of these intervals.
Risk management: some rules to exit a grid, such as using a stop loss or a certain percentage drawdown to exit the trade and cap losses.
A couple examples are explained below in detail to illustrate how this strategy works, why it can be more effective than betting on a certain direction and how it may be able to improve your trading performance.
Grid trading can take many forms, where one approach trades against the trend. The best buys are made when the price is declining or when there’s ‘blood in the streets’.
Similarly, it is better to ‘sell into strength’ rather than go short when the price is already heading lower and establishing lower lows. Another approach is to trade with the trend and profit from strong momentum in one direction or the other.
Let’s take a closer look at these two different approaches in turn.
The price of ETH is currently trading just below $1900 and has established a range between $1940 and $1840 over the past 6 days. When setting up a grid strategy, the upper limit could be $1940 while the lower limit could be $1840.
The next parameter to decide on is the grid number, which refers to the maximum number of buy and sell orders.
Let’s say we go with a grid number of 10, which means 5 buy orders are set between $1900 and $1840 at $12 intervals (at $1888, $1876, $1864, $1852 and $1840) and 5 sell orders between $1900 and $1940 at $8 intervals ($1908, $1916, $1924, $1932 and $1940).
The resulting grid is displayed by the chart below (an example of an arithmetic grid). Another option is to use a geometric grid, which would place the orders using a fixed percentage change from the starting price (instead of a fixed dollar amount).
As long as the current range is respected by the price of ETH, meaning that it continues to trade between $1840 and $1940, then the grid trading strategy is likely to be profitable. As a result, the trader does not need to worry about picking a direction for ETH. The 5 buy orders will all be in profit if the price dips to the bottom of the range at $1840, but then finds support and rises into the $1900’s.
Compared to the case where a trader goes all in at $1888, the grid strategy enabled the trader to get a better entry price by slowly scaling into a long position. The average entry for the grid trading system would be $1864 if each buy order uses the same position size (although you can also vary position sizes to buy more as the market approaches the grid’s lower limit).
However, the downside of grid trading is that if a strong trend develops, then the position becomes larger and larger, resulting in ever-increasing losses.
For instance, if the price breaks below the $1940-$1840 range and decreases to $1800, then these 5 buy orders incur losses. And if the price continues moving south, then the loss becomes larger. Therefore, it’s important to use small positions for each order. It’s best to think of grid trading as slowly scaling in and out of positions over a long period of time to generate returns that are slow and steady.
It’s also important to set a stop loss in case a price trend develops to minimize any losses. Alternatively, set a rule for the maximum percentage drawdown you’re willing to accept before exiting a grid.
The example above describes a grid trading strategy that goes against the trend. However, for a strategy that follows the trend, it looks slightly different.
Instead of placing limit buy orders below the current price, stop limit buy orders are placed at certain intervals above the current price to take profit from an upward trend. To take advantage of a downward trend, limit stop sell orders are placed at certain intervals below the current price.
An example is shown in the chart below for OP-USD. The current price is around $1.23 and the chart shows that the market has recently fluctuated between $1.05 and $1.50. To profit from an upward trend, several stop limit orders to buy OP are placed at $0.03 intervals above the current price.
Given the market has recently hit highs near $1.50, the buy orders will open long positions as the price moves higher and a limit order to close the position can be set somewhere between $1.40 and $1.50 to profit from a bullish trend.
On the other hand, profits can be made during a downward trend by placing several stop limit orders to sell between $1.20 and $1.11. The first stop limit sell order will be triggered when the price falls below $1.20 and the short position will gradually increase as the price dips below $1.11. Similarly, the short position can be exited at a profit somewhere in the $1.10 to $1.05 range using a limit order.
Compared to the case where a trader goes all-in on a breakout in either direction, the grid strategy scales in as momentum builds, providing a better risk-reward profile. As with the previous example, stop losses or a rule for the maximum drawdown for your account can be utilized to manage risk.
The major difficulties involved lies in deciding the price range in which to place the grid, which should be adjusted frequently to account for the volatility of the market being traded.
In the first example, we saw that ETH-USD was trading sideways between $1840 and $1940, but if volatility starts to decrease, the grid can be adjusted to lessen the gap between the lower and upper limits. On the other hand, if volatility becomes much more elevated, then the grid should be extended to account for larger price fluctuations.
Grid trading also requires an estimation of how far the price may go in either direction. Traders can use tools like the average true range or support and resistance levels to determine the lower and upper bounds.
Similar to market making, grid trading requires active management, meaning you have to think about how to trade your way out of these positions to generate a return. A big move in one direction or the other can cause big drawdowns if you’re trading against the trend. So you’ll need to focus on your exit strategy and make an informed guess of when a trading range has been invalidated or when a trend may start to reverse.
Finally, another factor to consider is that when there’s consolidation in the market, you’ll end up holding a position over an extended period of time. If you’re using perpetual swaps as part of a grid trading strategy, this could result in increased costs depending on the current funding rate.
In summary, grid trading is a non-directional strategy that embraces the randomness of cryptocurrency prices and can be used in sideways markets or trending markets. To conclude this article, it’s important to remember the following points.
For sideways markets, limit orders to buy are placed below the current price, while limit orders to sell are placed above the current price. As the price fluctuates within the grid, you are effectively buying low and selling high, generating a profit no matter what direction the market is heading.
For trending markets, stop limits orders to buy are placed above the current price, while stop limit orders to sell are placed below the current price. When the price breaks out in either direction, the position size increases and goes with the flow of the market, earning profits when there’s a strong trend in either direction.
The grid trading strategy is not for everyone: it is best suited to those that have a significant amount of capital and have a lot of patience. Also, this style of trading may be attractive to individuals that either have little knowledge of technical analysis or don’t think that it works at all. If you’re looking to make money fast or you don’t have a lot of capital to begin with, then a grid strategy is probably not going to be the best option for you.
The main benefits of this system are: it is a simple strategy with a high win rate that requires you to pick out the key price levels you think will be respected. Also, there’s no need to predict the market’s direction, reducing the pressure to find the perfect entry. Finally, the strategy can be automated, helping to remove the aspects of emotions and timing from the equation.
However, there are a few downsides for these systems. Grid trading delivers a slow and steady return, so it’s best used if you have a significant amount of capital and you can be very patient. Some monitoring is also required and you have to make decisions about where to exit at a profit using limit orders or stop limit orders beforehand. Finally, if there’s elevated volatility and the asset experiences sudden and sharp movements, then this can cause large drawdowns.