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.

Forex Carry Trade Bottom?

I'm probably never going to try to call a bottom, but I will point out that there is a difference in behavior since the recent panic drop. Now, we see the Yen based carry pairs bouncing off a resistance point instead of simply dropping as if they are in free-fall.

What am I doing about it?

I'm glad you asked. My current trading activity involves playing with a bit of a gridding strategy. When the price gets down near the recent resistance point I'll place limit buy orders above the price. This means that if the price rises I'll start filling orders. These orders have a small take profit zone so I won't have to worry about accumulating many positions, or risk, but I'll make an okay profit if the price decides to bounce back and forth for a while.

I've booked small amounts of incremental profit this evening in the EURJPY, GBPJPY and AUDJPY markets. Admittedly, the profit is very small per trade. However, if the price continues to rise and fall I'll be able to take that same small slice of profit during each cycle. It adds up!

Interestingly, if the price drops, I'll just extend my grids downward and catch whatever eventual upturn arises.

Don't forget, I like to accumulate long-term carry trade positions at what are apparent low points. I make sure not to overextend my account so that the sum of my open positions are not large enough to put my account at risk. So, if I end up holding on to some grid based trades for the longer term, I am fine with that.

Forex Gridding Strategy

Okay, I'm pretty much sold on this idea. Here are some advantages to gridding the AUDJPY on the upside:

• Each purchase represents a carry position while waiting for it to become profitable.
• Extremely limited downside risk when set up properly.
• Excellent earning potential in choppy market conditions.

Using my nano-account here is what I set up last night. Place a limit order for NNN units every 2 pips. When an open position is 15 pips positive place a stop loss locking in 5 pips of profit. When an open position is 20 pips or more positive then adjust the stop loss to 50% of the positive amount.

Once you have defined your setup, as above, you can calculate exactly how many open positions you may have to carry. So, in the above, you will only be left with 7 open positions at a maximum. This is because if you held 8 positions the bottom one should have a profitable stop loss set on it.

Of course, doing things by hand means that you'll have to close out your grid to avoid acquiring additional risk. It also means a fast movement could open a lot of positions before you have time to set stop losses. You can combat this by setting a static profit taking point, but given the small unit size of this particular setup I wanted to let my winners run.

I'm now considering a slightly different strategy:

• Place a limit order every 6 pips (spread is 4 pips).
• Place a take profit at 20 pips.
• Set the size of your purchase at a safe size.
• Wait for the market to move in your direction and collect your profits.

Sounds pretty cool to me. The only thing to watch for is the situation where the market moves partially through your grid, but not out of it, before moving back down. If you enter more positions you will be increasing your risk. You may just have to be patient!

As I was creating this post I got VERY busy setting profitable stop losses on my current open grid...