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Expert Advisors Reviews

Grids, Martingale and Hedging explained

Jul 18 2017
By
Jonathan Smith ,

This article will attempt to explain some of the most commonly used concepts in Expert Advisors. It’s worth mentioning, they can be used in manual trading as well, but their popularity has grown with the automated crowd. We will showcase some highly risky systems, which we do not recommend. The purpose is to educate you about the dangerous nature of these strategies.
 

What is a grid?


A grid is exactly what it sounds like – graphically splitting the chart in even portions, in terms of price and time. If you have traded with MetaTrader 4 (MT4), the most popular currency trading platform, you would know what a grid is. But how is a grid used, in terms of creating a trading strategy? There are lots of variations, some of which we will look at in this article. In order to understand them, you will need to be familiar with the next two ideas. Here is a graphical representation of a grid:



 

What is Martingale?


Martingale is a concept which comes from gambling. It is the idea, that you can make back your losses by increasing your bet. If you participate in a game with a binary bet, like say betting red or black in roulette, you would initially place a 1 unit ($1, for instance) bet. If you lose, you have to make a 2 unit bet. If you win at this point, you would have won 2 bets. after losing the initial one, hence you will have 1 betting unit in profit. What happens if you were to lose the 2 unit bet? You double again, placing a 4 unit bet. If it wins – you would still have a single unit worth of gains (after losing 1 + 2 = 3 units in the first two rounds and winning 4 in the third one). This logic goes on indefinitely. Can you spot the problem?
 

Other than the obvious problem of the house edge in roulette, which comes from the inclusion of the 0, long streaks of the same color can occur. For instance, if you lose ten consecutive bets, you would have to place a 512 unit bet, after having lost 511 units already. At this point you would have to have to be well capitalized and be aware of the maximum bet allowed at the table.
 

When it comes to trading the implications of a martingale strategy are adding to your position, as the market moves against you. Your main goal would be to wait for a market correction and close a small profit. The main problems are similar to the ones mentioned in our roulette example – the market can move in one direction, without a serious correction for a long period of time and you would need an adequate trading account. Most martingale EAs have pretty smooth looking profit chart, with a couple of massive spikes down in equity, until the final one, which wipes-out the account.

 

What is “hedging”?


The term hedging generally refers to lowering your risk, by opening a position in a similar, but correlated asset class. When it comes to retail forex trading, and especially these type of systems, hedging refers to having a long and short position in the same currency pair at the same time. This is widely considered to be a dubious strategy and is prevented by the implementation of the “First In, First Out” (FIFO) rule in some jurisdictions, the most notable of which is the US.
 

Why would anybody want to open the opposite position, instead of simply closing their previous one? The short answer is “to gain a strategic edge”. Two of the strategies we will briefly describe below feature this element and you will get a lot more clarity on the issue.

 

Some strategies:


Classic Martingale
If you combine the knowledge of what a grid is and what the martingale principle is, you could clearly figure out what the simplest strategy is. You enter the market and if it goes against you, you would have to enter it again (this is called averaging down) with double the size. For instance:


You go short for 1 lot at 1.1000 and decide to use a 100 pip grid. The market then moves to 1.1100 and you short for another 2 lots. Your aggregate position is 3 lots short from 1.1050. If the market goes slightly below this level you close the profit.


What should you do if the market continues to move higher? Keep shorting, this time with 4 lots. And the logic continues. Here is a graphical representation of this system:
 


In essence this strategy relies on a single leg in your favor, to recover the losses. While it may sound tempting, this system is very dangerous as it will eventually fail. We must note, the lot sizes given in the example are very high. Most systems start with 1000 currency units or 0.01 in MT4.


Furthermore, most traders recognize this is a losing system and have made some adjustments. The most common one is not using such a strict progression (doubling for the next position), but simply increasing it slightly. For instance 0.01, followed by 0.02, 0.03, 0.05 and so on. Additionally, more advanced versions include other technical indicators to judge which direction to enter, or whether or not to add to the position. However the core risks always remain in place.

Opening a long and short at the same time
Let’s look at another interesting variation, which still carries a lot of risk. This system requires the opening of a long and short trade at the same time. This may sound very illogical, but there is a method behind the madness. The idea is you will do that again if the market moves in any direction, by the grid amount you have predetermined. In essence you do not increase the lot size, but carry the risk of a significant loss if the market moves much further. Here is an example:


You open a short and long position at 1.1000, with a 100 pip grid size. You would then have to wait for the next 100 pip move and close the winning trade and open a new long and short position. Then you would wait for the market to return to 1.1000, where you close all of the trades. What would your result be?



Position Result Closed at
Long from point 1 +100 Point 2
Short from point 1 0 Point 3
Long from point 2 -100 Point 3
Short from point 2 +100 Point 3

 

You would have a 100 pip (or one grid level) profit. This seems pretty cool, right? Where is the catch? The catch is that at point 2, you were carrying a 100 pip losing position. Had the market continued to move higher, it would have increased. Could you have just continued with the system? Yes, to a certain extent.
 

To give you the short version, you would still have made 100 pips if the market had moved an additional 100 pips higher and retraced to 1.1100. If the marker moves another grid level higher (to 1.1300) and retraces to 1.1200 – you would break even.


The fourth level is where losses start occurring and if you haven’t figured it out, they are rather big ones. At this point you would probably have to close out the trade, with a 600 pips loss … ouch. This is due to the fact you have cashed in all the winners (similarly to how the long from point 1 is closed at point 2, in our example), but left the losing trades opened. This strategy may work in range-bound markets, but once price takes off.

Hedging with double the size

This system is a bit different and often used by manual traders. The idea is that after you enter the market and it moves against you, you would enter with double the size … in the opposite direction. This is the equivalent of closing your initial position and opening a new one, following the market move (or flipping). The idea is to keep all positions open and eventually decide when to close the winning trades.

What do you do with the losers? You wait for them to retrace or close them at smaller losses than your closed winners. This is definitely a more advanced technique and requires some judgment. Although this strategy appears to benefit from market trends it does carry some of the risks involved with the previous two.
 

Conclusion


All of these strategies were revealed for educational purposes. You should judge, whether they suit you, depending on your risk tolerance, which should be limited to ... basically your entire trading account. Although these systems may appear to be a “sure thing”, keep in mind, there are no sure things in trading. Hopefully now you understand why we warn against certain expert advisors, which utilize similar systems. A strongly trading market is the nemesis of these strategies.
 

TAGS: grid  martingale  hedge  hedging  ea  expert advisor  forex robot 
Broker Country Regulation Platform Min Deposit Review
Cyprus, UK, Mauritius CySec, FCA, FSC MT4, MT5, Web $10 Review Website
Cyprus, SVG CySEC MT5, Web,
cTrader
$100 Review Website
Australia, Cyprus ASIC MT4, MT5,
IRESSTrader
$100 Review Website
UK, Cyprus, Australia FCA, CySec, ASIC MT4, MT5 $5 Review Website
UK, Australia, South Africa FCA, ASIC, FSCA MT4, Trading
Station,
NinjaTrader
$50 Review Website
UK, Cyprus, UAE, South Africa FCA, CySEC, DFSA, FSB MT4, MT5, FxPro
Markets,
cTrader
$100 Review Website
Cyprus CySEC MT4, MT5, Web $1 Review Website
Belize IFSC MT4, MT5 $100 Review Website
Cyprus, UK, South Africa, UAE CySec, FCA, FSCA, DFSA MT4, MT5, Web $5 Review Website
Cyprus, UK CySEC, FCA MT4, MT5 $1 Review Website
UK FCA MT4, Web, MT4
for Mac
$100 Review Website
Australia, UK ASIC, FCA MT4, MT5,
cTrader
$200 Review Website

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