Grid trading strategy

The rule of thumb of grid trading strategy is that position strategy is more important than timing. Basically, the grid trading strategy is a technique where a certain number of sell or buy orders are placed at regular intervals above or below a set price to target gains instead of stopping loss. Where a position’s market price meets a predefined target and a gain is recorded upon closing, the same number of buy or sell orders are placed above or below the set price again. This creates a fishing net-like grid of orders for gaining profits back and forth in the fluctuating market.

It is plain from the above that grid trading strategy’s core is to achieve profitability based on the concept of “mean reversion”. Grid trading strategy applies very well to fluctuations. A difference between every arbitrage trading pairs is subject to “regression” in nature. For example, a futures contract’s price is eventually subject to regression to its spot price, and prices of perpetual and futures contracts are also subject to “regression”. Therefore, grid trading strategy and arbitrage trading are considered as twins in the coin market.

Medium-to-low frequency grid trading strategy

Take OKEx’s BTC Swap and BTC Quarterly as examples, the difference is calculated as the former’s price minus the latter’s price. The following chart displays the fluctuations in the difference from 27 July 2019 to 27 August 2019. It is obvious that the difference fluctuates between approximately +1% and -3%. The curve hits the 0-axis for a couple of times.

Steps to employ grid trading strategy:

Take the long grid as an example:

We place a long order once the market price moves one interval lower. When the market price falls, we open 3 long positions at Buy 1, Buy 2 and Buy 3 in order (i.e. Buy 1, Buy 2 and Buy 3 shown above, representing the opening of 30 long perpetual contracts and 30 short quarterly contracts); and when the market price rebounds, we cover positions at Cover 3, Cover 2 and Cover 1 in order (i.e. Cover 1, Cover 2 and Cover 3 shown above, representing the covering of 30 long perpetual contracts and 30 short quarterly contracts). The profit is calculated as 3 * a price of one interval. This is also the case for the short grid.

Since it is fundamentally assumed that the difference is subject to regression to 0, we create long grids or short grids if the difference is below or above 0 respectively. Based on the same assumption, we just need to close out positions after the market price rebounds, instead of stopping loss upon opening.

Risk analysis

Theoretically, grid trading strategy is a sort of absolute return strategy employed by medium-to-low frequency trading investors in arbitrage trading. In a mid-to-long term, the amount you invest is supposed to be risk-free. However, practically, you need to consider the potential risks in doing investment.

Forced-liquidation risk in one-sided market

Hedging strategy can normally be used for arbitrage. Although the hedge prices of equal long and short positions are subject to fluctuation, it is likely that a leg fails after you may not have sufficient cover against uncontrollable risk due to a high fluctuation. Therefore, you should opt for a lower leverage ratio and transfer margins to protect other positions when the loss is higher than expected.

Transaction fees and funding fee

As you earn profits during fluctuations in arbitrage trading, the profit per transaction is relatively low. You need to ensure that profits can cover transaction fees and funding fee by creating larger grids in using medium-to-low frequency grid trading strategy.

Problem in trading futures contracts

It is likely that the difference is not subject to regression upon closing of a contract. You should only cover positions when you are near closing a contract. Initiative should be taken to cover all positions prior to closing.

Conclusion

In summary, grid trading strategy involves very little risk. You can lock in profits without observing price fluctuations after gaining a better understanding of the strategy. In the meantime, transaction fees are generally lower in medium-to-low frequency grid trading than in high-frequency grid trading. Manual operation is feasible even if you are unfamiliar with programming.


Disclaimer: This material should not be taken as the basis for making investment decisions, nor be construed as a recommendation to engage in investment transactions. Trading digital assets involves significant risk and can result in the loss of your invested capital. You should ensure that you fully understand the risk involved and take into consideration your level of experience, investment objectives and seek independent financial advice if necessary.


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