Gold bugs add enormous liquidity while keeping a floor under futures and gold stocks, because they provide a continuous supply of buying interest at lower prices. The chart below shows gold futures GC and yen futures J6 and it is not hard to see how these two assets tend to be closely correlated.
It appears that the economy is beginning to rise again, oil is beginning to see some weakness and the housing market is becoming bullish once again. All signs point to a bearish gold cycle that may end up erasing most of the gains that we saw over the last several years. As you know markets drop substantially faster than they rise so be prepared for a very quick price correction in the gold market. You can see in this chart a few different support levels that gold will have to go through, but in my experience the correction can bring back prices to the low hundreds within the next 2 years.
Take a look at the following ETF that correlate strongly with gold prices. You can tell that the stock is following along with the rest of the sector almost tick for tick. Our job is to find two stocks in the sector that are highly correlated, this will help decrease risk and increase profits when applying relative strength strategies to two separate stocks.
You want to find the two of the most correlated and closely traded stocks possible for the strategy to work best. These are the two stocks that we will be using for our relative strength trade. Notice how the two stocks almost like identical when analyzed on a bar chart. Keep in mind that you want to find the closest correlation possible. The strategy attempts to capture trending moves in gold-related ETFs and trusts.
This should ideally be done when there is adequate market volatility. Otherwise, the trends are more likely to run out of steam and not reach our profit target. The profit target is based on a multiple of our risk. During more volatile conditions, the target could be extended to 24 or 32 cents above the entry price three- and four-times risk, respectively.
The strategy is not without pitfalls. One of the main issues is that the pause within the pullback can be quite large, which in turn will make the stop and risk quite large. There may also be multiple pauses within a pullback; choosing which one to trade can be rather subjective. The profit target is fixed at a multiple of risk in order to compensate traders for taking that risk. An optional step is to move the stop to just below new lows as they form during an uptrend, or move the stop down to just above new highs as they form during a downtrend.
When volatility increases, though, day trading is warranted. Focus on trading with the trend. Wait for a pullback and a pause in price. The pause is what provides the trigger to enter the trade. Place a stop just outside the pause in price. Your target should compensate you for the risk you are taking; therefore, set a target of two times your risk — or potentially more in volatile conditions. At the time of writing, Cory Mitchell did not own any of the securities mentioned in this article.
After the entry, place a stop loss just below the pullback low. No thanks, I prefer not making money.
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