Demystifying Dow Theory: 6 Principles Every Trader Should Know

Grid Trading Explained

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 Examples

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.

Buying Blood and Selling into Strength with Grid Trading

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.