After a brief hiatus, Gold is returning to my radar screen. With downside momentum in check and a successful hold of previous support, Gold may make that push to make a strong finish to this year. How can a trader take advantage of this market?
I find that a longer term focus using a trend following methodology works best for me. Ultimately, I use the 9 day simple moving average to tell me what the short term money pressure is on the market, and I look at the 50 day moving average to tell me what the long term money pressure is. If the 9MA is above the 50MA, the market is in a bullish stance, and I would look for buy entries. If the 9MA is below the 50MA, the market is bearish and I would be looking for an opportunity to sell.
Currently in Gold, the 9MA is about to move above the 50MA, indicating that we should be looking for buy entries. This is reinforced by the MACD. I use a 9/50 compression on the MACD to complement my use of the 9MA and the 50MA. In late October, we saw a MACD cross, indicating a shift of momentum to the upside.
The conservative trader should wait for a day in which the 9MA settles above the 50MA prior to entering the market. A more aggressive trader could be looking for entries now. But what are the possible trades?
When using the trend following methods that I use, I caution not to use the technical indicators (the moving averages or the MACD) as both a screening tool AND an entry tool. Rather, I prefer to use price action to determine specific entries and exits. The most conservative entry is to buy a breakout of resistance. In the case of Gold, round numbers are key psychological barriers and therefore make good points to watch for breakouts - 620, 630, 640 will be key. Also, a breakout above previous resistance is a good entry. The market is breaking out today, the next preciously tested resistance level would be the 648.50 level. I find 620 to be significant as well as it has been a previous area of support.
For more precision, one could wait for a setup using the 20 day exponential moving average. This trade setup occurs when the market pulls back and settles below the 20 day exponential moving average, then makes an attempt to regain the high of the day that settled below that level. The textbook trade is to buy the open of the following day. However, traders employing this technique are cautioned to wait for confirmation that we are in an uptrending market ( i.e. the 9MA has crossed the 50MA).
Alternatively, more conservative traders could employ option spreads in Gold. An option spread, such as a bull call spread, gives a trader the opportunity to participate in the market with a limited risk position (the risk on a bull call spread is limited to the cost of the position). The advantage to using a spread like this, as opposed to buying a call option outright, is that for similar cost, a trader can often get a position that is closer to the actual market price. The tradeoff in this trade is that the upside potential is capped at a maximum amount (the difference between the strikes).
Here is an example. A trader would purchase a 640 call February 2007 gold while simultaneously selling the 680 call. The 640 call currently has a theoretical value of approximately $1800. The 680 has a theoretical value of about $880. To construct a bull call spread, the trader buys the 640 call for $1800 and sells the 680 call for $880. The difference is $920. That is the net cost of the position and the maximum that the trader can lose on the trade.
But how much can he make? If Gold is trading at or above 680 at expiration (85 days from now), the position would be worth the difference between the strike prices. This is $4000. Take away the $920 that the position cost and the maximum net possible gain would be $3080. This is approximately a 1:3 net risk:reward ratio (1:4 gross). When constructing option spreads, I find this to be a reasonable number and I seek out trades that are at least 1:3 risk versus reward.
But what about the outright call positions? Well, for the same money as our spread trader, a trader would have to go to the 675 call in February 2007. The current theoretical value is approximately $966. But for that to be a better trade, Gold would need to be trading above 684.66 at expiration just for us to break even (675 strike + 9.66 paid for the call). To beat the call spread, we would need to be at $715.46. Now, if we were expecting gold to be trading well above that, the outright call would be our preference. But the call spread gives us a good look at the upside while keeping us in a limited risk position.
Certainly, for the trader willing to take the risk, the outright futures are trade to take. You get a 1:1 look at the market, while the market will have to make significant strides for the outright call or the call spread to benefit. But risk has to be considered with that. Traders looking to get long on either a breakout move, or on a 20EMA setup, a stop at key support would be necessary. For me, this is the 565 area. I would want my stop to be somewhere outside of that area, looking at 560. If the market clears and settles above the previously outlined resistance areas, the stop could be trailed behind accordingly.
I have outlined some broad trading examples here to take advantage of a building uptrend in Gold. But there are some caveats. First, if you do not understand the risks of any of these trades (or any trade for that matter), you are advised to do nothing until you fully understand and are comfortable with the risks. Second, these are some broad examples. They are geared to more intermediate to advanced traders that can work them into an already sound trading plan. If you lack a sound plan and the discipline to execute it, you would be wise to discuss a plan with a market professional prior to taking any action.
I find that a longer term focus using a trend following methodology works best for me. Ultimately, I use the 9 day simple moving average to tell me what the short term money pressure is on the market, and I look at the 50 day moving average to tell me what the long term money pressure is. If the 9MA is above the 50MA, the market is in a bullish stance, and I would look for buy entries. If the 9MA is below the 50MA, the market is bearish and I would be looking for an opportunity to sell.
Currently in Gold, the 9MA is about to move above the 50MA, indicating that we should be looking for buy entries. This is reinforced by the MACD. I use a 9/50 compression on the MACD to complement my use of the 9MA and the 50MA. In late October, we saw a MACD cross, indicating a shift of momentum to the upside.
The conservative trader should wait for a day in which the 9MA settles above the 50MA prior to entering the market. A more aggressive trader could be looking for entries now. But what are the possible trades?
When using the trend following methods that I use, I caution not to use the technical indicators (the moving averages or the MACD) as both a screening tool AND an entry tool. Rather, I prefer to use price action to determine specific entries and exits. The most conservative entry is to buy a breakout of resistance. In the case of Gold, round numbers are key psychological barriers and therefore make good points to watch for breakouts - 620, 630, 640 will be key. Also, a breakout above previous resistance is a good entry. The market is breaking out today, the next preciously tested resistance level would be the 648.50 level. I find 620 to be significant as well as it has been a previous area of support.
For more precision, one could wait for a setup using the 20 day exponential moving average. This trade setup occurs when the market pulls back and settles below the 20 day exponential moving average, then makes an attempt to regain the high of the day that settled below that level. The textbook trade is to buy the open of the following day. However, traders employing this technique are cautioned to wait for confirmation that we are in an uptrending market ( i.e. the 9MA has crossed the 50MA).
Alternatively, more conservative traders could employ option spreads in Gold. An option spread, such as a bull call spread, gives a trader the opportunity to participate in the market with a limited risk position (the risk on a bull call spread is limited to the cost of the position). The advantage to using a spread like this, as opposed to buying a call option outright, is that for similar cost, a trader can often get a position that is closer to the actual market price. The tradeoff in this trade is that the upside potential is capped at a maximum amount (the difference between the strikes).
Here is an example. A trader would purchase a 640 call February 2007 gold while simultaneously selling the 680 call. The 640 call currently has a theoretical value of approximately $1800. The 680 has a theoretical value of about $880. To construct a bull call spread, the trader buys the 640 call for $1800 and sells the 680 call for $880. The difference is $920. That is the net cost of the position and the maximum that the trader can lose on the trade.
But how much can he make? If Gold is trading at or above 680 at expiration (85 days from now), the position would be worth the difference between the strike prices. This is $4000. Take away the $920 that the position cost and the maximum net possible gain would be $3080. This is approximately a 1:3 net risk:reward ratio (1:4 gross). When constructing option spreads, I find this to be a reasonable number and I seek out trades that are at least 1:3 risk versus reward.
But what about the outright call positions? Well, for the same money as our spread trader, a trader would have to go to the 675 call in February 2007. The current theoretical value is approximately $966. But for that to be a better trade, Gold would need to be trading above 684.66 at expiration just for us to break even (675 strike + 9.66 paid for the call). To beat the call spread, we would need to be at $715.46. Now, if we were expecting gold to be trading well above that, the outright call would be our preference. But the call spread gives us a good look at the upside while keeping us in a limited risk position.
Certainly, for the trader willing to take the risk, the outright futures are trade to take. You get a 1:1 look at the market, while the market will have to make significant strides for the outright call or the call spread to benefit. But risk has to be considered with that. Traders looking to get long on either a breakout move, or on a 20EMA setup, a stop at key support would be necessary. For me, this is the 565 area. I would want my stop to be somewhere outside of that area, looking at 560. If the market clears and settles above the previously outlined resistance areas, the stop could be trailed behind accordingly.
I have outlined some broad trading examples here to take advantage of a building uptrend in Gold. But there are some caveats. First, if you do not understand the risks of any of these trades (or any trade for that matter), you are advised to do nothing until you fully understand and are comfortable with the risks. Second, these are some broad examples. They are geared to more intermediate to advanced traders that can work them into an already sound trading plan. If you lack a sound plan and the discipline to execute it, you would be wise to discuss a plan with a market professional prior to taking any action.
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