How To Apply Relative Strength To Gold Trading Strategies
Over the last several months gold prices have very volatile. During this period of time I received several emails asking me to demonstrate gold trading strategies that work in these market conditions.
So today I’m going to demonstrate simple relative strength trading methods that apply to the gold market. The timing couldn’t be better because recently I wrote an article which explains how to apply relative strength to the stock market. If you didn’t get a chance to read the article just click this link.
Over the last 12 years the Gold market saw one of the biggest bull markets in history. I remember gold prices in 2000 around the 280 level and peaking around the 1900 level just over a month ago.
You can see the entire progression of the upswing in this monthly chart of gold prices. Notice the strength of this market, there’s only a handful of down months over the entire length of the bull market.
The war, decline in economy and several other fundamental factors were there primary catalysts for the beginning of this rally.
Like most things in life, everything has to come to an end and the bullish gold market is no exception. 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.
Because the gold market is such a large and popular market there are dozens of stocks and a few great ETF’s that you correlate over 90 percent with the spot gold prices.
This means that you don’t have to buy or sell gold bars or open a futures account to take advantage of this down trend.
Take a look at the following ETF that correlate strongly with gold prices. It’s hard to imagine correlation getting any closer between the cash market and these stocks.
Take a look at this chart of Gold Corp, this is one of the biggest stocks in the gold sector and is part of the GLD ETF as well. 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.
The other stock I want you to pay attention to is Newmont Mining, which is another large gold player and is also part of the GLD ETF.
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.
Once you identify two very closely related stocks it’s time to decide which one you want to see and which one you want to buy. The rules are very simple in this regard. You sell the weaker of the two stocks and you buy the stronger of the two stocks, it really doesn’t get any simpler than that.
Just line up the two stocks like I did on this chart and see which one is down the largest percentage out of the two.
In this example you can see how Newmont Mining is down over 30% while GG stock is down only about 22%. You would initiate a long position on GG stock and initiate a short position on Newmont Mining.
The last and the most important step is to equalize your positions so that the stock going up and the stock going down have equal or as close to equal exposure as possible.
You don’t want disproportionate gains and losers on this type of position. I’ve done several tutorials on position equalizing and you can find them at MarketGeeks.com or on our video channel.
Wishing you the best
By Roger Scott