A grid trading system is a method of adding on every few points or pips as the market is progressing or regressing.
For example, let’s say you buy EURUSD at $1.130, you would also add on $1.125 and if the price goes to another low, you would add again at $1.200. In a well executed grid system, the trader is adding on as much as the price goes into certain directions.
When we breakdown this system, we see that what it actually does is create an average price for your trade. On the same asset, if you have 2 different entries, you would create another price which is called the average price. Let’s say you have two similar size trades, one at 1.1300 another at 1.1250, then the average of those will be the average of the whole position.
The benefit of this setup is that you can have a prefered break even if price goes against you because you’ll add on while the price is regressing against you.
Enforce your Threshold for Loss
Before you begin to map out a successful grid trading strategy, vow to yourself that you’ll be taking the maximum loss that you define for each trade.
Also consider multiple entries on the same asset as one trade and one position with one average price. It’s essential to limit this to a loss that you will be taking.
Manage your stop loss or your risk taking up to a defined amount of pips or money or percentage. Promise yourself that you will enforce it and not go endlessly on more averaging and bringing more weight. The more that you add, the heavier the position will go against you.
This can ultimately lead to a margin call.
A Major Trap
As good as this setup sounds in theory, it also has a significant trap built into it. The main problem with a grid system is that It takes you away from the responsibility of having a proper trade management plan. It also encourages you to avoid taking the proper responsibility over your analysis.
The trap basically means that traders who tend to grid their positions are actually in a state where they’re denying taking losses. This on its own is a very big hole and warning sign in your trading plan.
If you don’t realize that you should be taking some losses and if you don’t accept that losses are part of the game and need to be cut short, not eliminated, this is a problem that can quickly turn into a total destruction of your trading work.
Multiple Chances but at a Steep Cost
Many intermediate traders at one point will find out about averaging price. Most get excited because initially, it’s like in a video game where you can approach the same task with multiple lives and chances.
In trading with a grid system, there are more chances to make a profit, however since it’s real life and your money is at stake, it’s possible you’ll need more than 3 lives to recover from a bad analysis or bad entry. It doesn’t matter if the fault comes from you or the market tricking you.
The fact that you’re trying to avoid or deny taking a loss should be an immediate red flag.
Potential to Go Beyond Your Preferred Risk Zone
Trading with a grid system isn’t necessarily a misuse of your trading analysis setup unless you did it up to and past a specific risk that you intended to take.
When you think a grid strategy is good for you so you can take more chances on your position to recover, you still need to mind overall risk management. In order to do so, if you know that in your plan you have this grid technique, you should start from the beginning with the consideration of using grid. Early on in your trading plan, define where and when to stop and take the final loss on a trade.
Most traders who use grid fail to stop themselves at the right time because the grid gives them more probability to eventually win out. While it’s true, this also means that the times that they do not win out, they will suffer severe losses.
In most cases you might end up on the hero side but it takes only one mistake to tumble your portfolio into a severe loss, destroying months of hard labor.
How to Use a Grid without Destroying Your Overall Portfolio
If there is a potential to use grid or averaging price, your position size from the first entry must consider this. You have to cut your entry size in a way that will allow you to do some gird averaging if the market goes against you.
If you don’t have this plan, you need to go back to the drawing board and define the mathematics for your trading strategy. If you consider this strategy, it has to be from the core, starting point of the entry.
You have to define yourself how many retries or new positions you ought to take. This is very important because you cannot go all the way down to a full margin call. You have to know where you to stop your risk taking on the specific trade.
Challenge the Temptation
It’s really tempting to believe that the market is going to go in your direction.
In a grid system, it’s very hard to avoid taking an extra grid, or an extra entry. You have to be very aware that this is a highly addictive trading manner and you have to restrain yourself and stop yourself where and when you decided prior to the trade.
Sometimes the market will cause losses and you need to accept that. If you can’t stop yourself when you need to, you shouldn’t consider the grid system.
The key in trading is knowing how to take losses.
Try to Use Grid on Positive Basis
When you reenter the market, do it on the positive side. Add more weight when the price progresses and gains. Use these gains to get more leverage while you’re profiting.
Use it less when you need to recover losses or to be wishful in your thinking.
Before adding weight, ask yourself whether it’s wishful thinking or it’s really based on the pre analysis you’ve made before the trade. Know your levels before and plan your grid on your analysis accordingly.
Follow these tips, avoid the traps, and ultimately determine if trading via a grid system is best for you and your unique style of trading.