How Do You Catch a Falling Knife?

Gordon Scott  |

Gold, Silver and Copper prices fell dramatically during the past week, but is that an indication that those markets have topped out or are they simply correcting and creating a new buying opportunity?  Some have opined that for various reasons, gold could still be expected to hit $3000 an ounce. If that were to happen, the current prices of these metals would make them a bargain hunter’s dream. But as the saying goes among traders, better to pick up a knife after it has hit the ground than to attempt catching it as it falls. You don’t want to try to guess where this free fall will end. Let the prices hit bottom and begin the climb back before trying to buy.

Let It Hit the Ground

What clue might let us know that these markets may have hit a low worth considering? The answer may be found in studying the movement of the Average True Range (ATR). The ATR is a technical study with a wealth of information. It measures the difference between the high and the low of a given chart period and even includes gaps in its calculation. Consider the following example using a 10-day ATR compared to the price of SPDR Gold Shares (GLD) to demonstrate how you can use it to forecast a trend change.

If the ATR is increasing rapidly, it means that market participants are becoming increasingly uncertain about whether that level can be maintained. This is a warning signal that a dangerous top may be near. But once the top has been reached and the correction finishes, the ATR will make a significant decline before the price begins to rise. For GLD, a 30% decline in the ATR appears to be significant.

In GLD’s multi-year uptrend, the 30% ATR retracement has been a good indicator of when a price correction may have fully run its course. The current drop in metals prices seems quite drastic and may signal the end of this uptrend all together.

Can the metals lie on the floor for long?

However, if you consider the fact that the Fed’s most recent action, though not QE3, was still an action taken to create more banking system liquidity and to help ease monetary lending policies, you can conjecture that asset prices should continue to have upward pressure in the months ahead. If that plays out, then gold, silver and copper should all find a price floor at some point and then continue their upward trends—even if a the trend is bit more subdued than it has been previously. But we are not at such a point just yet. Watch for the 10-day ATR to complete it’s 30% decline from its most recent peak value, and then begin mining for the shiny trade opportunities among the dusty metals.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:

Market Movers

Sponsored Financial Content