Theory: Gridding Microtrades

I've been thinking about grid based strategies designed to take advantage of volatility without incurring great risk.

The idea is that the strategy be followed using a carry trade pair in the event that you do inevitably end up holding some positions. You'll want a platform with a decent spread. Oanda often has about a 3.0 pip spread on the AUDJPY pair -- my current pair of choice.

So, let's start with these parameters:

• Every 20 pips have a limit order with a take profit of 20 pips.
• Each order is for 125 units (not lots).

What does this mean? It means that we will earn approximately a penny per pip of movement. It also means that a sustained downturn will accumulate positions at a very slow rate.

Note: I'll be throwing around numbers very loosely, if you want to consider this type of strategy seriously you'll want to account for spreads and other issues very accurately.

However, as I'm sure you can imagine, not all currency moves are for 23 pips or more. There are a lot of small moves that would be contained within a 20 pip range. There are a lot of moves that would rise and fall above the purchase price without being sold for a profit. This is missed opportunity.

You can easily calculate your risk... just assume a straight fall to some absolute low with a position acquired every N pips. Don't forget to account for the losses as purchases at higher levels will be suffering losses as well. How much capital do you need to sustain all of that?

What if you placed limit orders every ten pips and maintained a 20 point take profit stance? You'd double the theoretical maximum at risk and earn 2 cents per pip (over larger distances) if you kept the position sizes the same. It get's interesting when you decrease the size of the positions to reduce risk. Once you do that you can increase the density of your positions.

The interesting question is how much movement can you profit from as you increase position density, to catch smaller moves, given the spread on the pair you are trading? How many pips can you catch in a day without being in danger of accumulating more than you can handle in a downturn?

Practical risk reduction steps could be taken...

• You could place limit orders above the current price to avoid buying positions on the way down.
• You might also decide to trade only during periods that certain conditions are met.
• You might stop trading if you accumulated a large net position
• You should eventually make some profits which has the result of increasing your capital and adding to your total risk capacity.

This again gets interesting. If you assume you stop accumulating positions at a safe point you could easily recapitalize your account to start trading again within a lower range. While you trade with this new capital, within safe limits, you'll have a carry trade position which should have a reasonable average price in the bigger picture measured in months and years.