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How to Grid Trade
FOREX
FOREX (or foreign currency) traders buy and sell currency to make money off the fluctuations in currency exchange rates. Grid trading is a strategy designed to reduce risk by making the success of a trade independent of the direction the market moves. It can be an effective approach provided the currency traded is not in a strong upward or downward trend (in which case grid trading will not work well). Grid trading is a sophisticated strategy, and requires a degree of expertise. However, it's easy to understand the basic idea of how to grid trade FOREX. To follow how grid trading works, you need to know that a sell order makes money when the exchange rate falls and a buy order makes money when the exchange rate rises.
- Start to grid trade FOREX by opening a buy and a sell transaction on the same currency. We'll use the euro and US dollar currency pair as an example. Assume the starting price is EUR/USD = 1.3000 (meaning it takes $1.3000 to buy one euro). Note the quote is taken to 4 decimal places. In Forex, the smallest price change is 1/100 cent (called a pip), or $0.0001. To start, the grid consists of 1 buy at 1.3000 and one sell at the same exchange rate.
- Set your target price levels. Some traders do this by placing orders to automatically close out a buy (or sell) when a target price is reached. To keep it simple, we'll use a target of plus and minus 100 pips or one penny (usually the difference is smaller). The target in our example for the buy is 1.3100 and for the sell, 1.2900.
- Close out the gain when a target price is reached. For example, if the exchange rate falls to 1.2900, close out the sell. At this point, you have a 100 pip profit on the sell which is now closed. The buy is showing a 100 pip loss, but is still open.
- Open a new sell and buy at the target price, each with its own target price at plus and minus 100 pips. In this example, the second buy and sell are at 1.2900 with targets at 1.2800 and 1.3000.
- Wait for the exchange rate to fluctuate back to 1.3000. When this point is reached, the second sell will show a 100 pip loss. However, the first buy will be back to its original level, wiping out its loss and the second buy shows a 100 pip gain, offsetting the 100 pip loss on the sell side. The net gain/loss in the open transactions is now zero.
- Close out all three transactions if you are done trading for the day. The first buy shows no net change. The second buy is at plus 100 pips and the second sell is at minus 100 pips. However, remember you already closed out the first sell for a 100 pip profit, which is yours to keep since all transactions are now complete.
- Close out only the transactions that have reached their target level, instead of closing out all transactions and open new buy and sell pairs as appropriate. Normally a trader will continue this process throughout the trading day, accumulating profit with each swing of the exchange rate up and down, and close everything out only at the end of the trading session.
How to Determine FOREX Liquidity
- Liquidity is one of the best friends traders have because it provides enough buyers and sellers to allow traders to make transactions when they want to and at prices close to what they expect. If you are a foreign exchange -- or Forex -- trader, ample liquidity reduces gaps in prices to make it easier to apply technical analysis and manage risk. The Forex market offers attractive liquidity, but it has some quirks traders must prepare for.
Hard to Measure
- It is impossible to measure exactly how much liquidity the Forex market has. While many stocks and commodities trade on an exchange and all trades are reported to a central office, Forex trades are conducted over the counter between individual brokers or institutions. The broker who handles a trade will offer software that shows liquidity in the trades made by that broker and even trades reported by other major players. Traders can estimate liquidity by noting the spread between buy and sell offer prices and the change in price between trades. Small spreads and changes in price indicate high liquidity.
Ticks and Spreads
- Brokers commonly express liquidity as an average of the past 24 hours, with the average of that period taken to be 100 percent. For example, an increase of 5 percent in current liquidity yields a reading of 105 percent. Average liquidity is calculated by dividing the number of ticks -- a measure of the time between trades and the number of trades in a period -- by the average spread. Heavily traded currencies show hundreds of ticks per minute, while lightly traded pairs might show one per minute or hour. The spread is the difference between what a buyer bids and what the seller asks. A small spread indicates high liquidity, with many buyers and sellers.
