Grid trading is a popular trading logic that can be simply understood as dividing the money in the account into multiple parts. Each time the price falls by a certain margin, one part is bought, and when the price rebounds by a certain margin, it is sold. This allows for continuous low buying and high selling, or high selling and low buying, within a volatile area, much like a grid.

This method was proposed by Shannon, who used this theory for trading for over a decade and achieved an annual compound return of 29%. However, this operation does indeed have some fatal weaknesses, which I will now analyze one by one.

Risk 1: Leverage.

The basic logic of grid trading is essentially buying against the trend when we are losing in a trade. As the price continues to fall, we keep buying in batches to average out the cost. As long as the market rebounds by a small margin, we can profit and exit.

However, the most taboo in this trading model is the use of leverage, as it amplifies losses. To illustrate with a simple example, assume a 10x leverage is applied, and 50% of the position is used. If the market falls by 10%, the loss would be 50%. If the market falls by 20%, the account would be wiped out. Therefore, I have always advised against using grid trading methods in high-leverage trading such as futures and forex.

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We can use grid trading in stock markets that do not have leverage, especially in our domestic stock market, which is long-term volatile and very suitable. If it is necessary to use it in the futures market, the leverage must be reduced.

Risk 2: The possibility of encountering delisted stocks and futures contract delivery.

Grid trading is a medium to long-term trading model. After buying during a market downturn, the market often does not rebound immediately after hitting bottom but instead consolidates at the bottom for a long period before turning from a decline to an increase. This requires a relatively long holding period, which can be a test of patience.

What if you encounter a delisted stock or a futures contract that needs to be delivered, and you have to close the position before the trend reverses, resulting in a stop-loss exit?

What to do in such situations?When we employ grid trading in the stock market, it is advisable to opt for industries with a lower risk of delisting, such as leading stocks in certain sectors or ETF funds for grid operations. Additionally, diversifying funds across several stocks and conducting grid trading on each can help hedge risks.

In futures trading, when using grid trading, it is crucial to choose contracts with a longer delivery period to ensure sufficient holding time.

Risk 3: Starting to buy from a high position and getting stuck at the high level.

Grid trading involves allocating funds proportionally and purchasing in batches, but our capital is finite, and the number of purchase opportunities is limited. We cannot keep buying indefinitely. If we start buying at a market high, and then encounter a significant market downturn, it can be quite uncomfortable. This is because a large portion of our funds is tied up at a high level, and we may not have enough capital to average down later. At this point, the average cost may be stuck at a high level, requiring a substantial market increase to break even, which depends on time and opportunity.

Therefore, when using grid trading, we cannot guarantee that we will always buy at a low level. Patience is required, and it is advisable to buy at least at a mid-level to have room for maneuver. Avoid chasing the market up; instead, start buying after a significant market drop reaches a relative low or tests support, which can help avoid the risk of getting stuck.

Risk 4: Unreasonable use of additional positions.

The method of grid trading is simple, but it demands a high level of skill in position management. If positions are used unwisely, such as using a heavy position initially and then a light position to average down after the market falls, the later positions will be small and unable to lower the average cost. At this point, the average holding cost will also be relatively high, and a significant market reversal will be needed to turn a profit, which could also result in a long-term trap.

There are two safer strategies for grid trading position management:

One is to use the same position for each additional purchase, avoiding the issue of an unbalanced portfolio. The other is to start with a lighter position and then increase the position size later, which results in a lower average cost after getting trapped, allowing for a quicker profit when the market reverses.

I strongly recommend using grid trading in the stock market, allocating funds to different stocks, dividing the funds into several portions for each stock, and starting to buy at relative market lows. Before buying, it is crucial to develop a comprehensive and detailed trading plan and to execute it strictly.The logic of grid trading is quite simple and does not require profound trading technical knowledge, but it does require a certain level of patience. Since it involves buying in batches and spreading across different stocks, it is a low-risk operational logic. Consequently, the profits will not be too high. However, if executed properly, it can outperform the majority of retail investors in the market.