The basis of our trading involves following the commercial traders. In our minds, the balance between the producers and the end line users of a commodity is the best estimation of fair value within a given market. Since the market’s balance lies in a continuous state of flux, we follow the momentum of the buying and selling between these two groups. This helps us determine the degree of panic between the respective groups and obviously, the impact that their actions may have on the underlying market. These are all issues that cut down on trading frequency but, increase both the odds and the magnitude of the anticipated market movement. Currently, the gold futures market is setting up one of these opportunities.
The gold market has been stuck in a narrowing sideways pattern for more than a year. The broad sideways action has been a classic example of this trading methodology. We’ve only done six trades in the last year with four winners to two losers. You can see the magnitude of the wins on this chart. Commercial traders have been active purchasers of gold, jumping on last week’s decline to cover 25% of their short position. This kind of buying has caused a significant jump in commercial traders’ momentum. Furthermore, this decline has pushed our short-term overbought/oversold indicator firmly into oversold territory. Our setup conditions have been fully met.
Finally, we’re left waiting for the buy signal to trigger. The gold futures need to bounce off this low with sufficient force to push our short-term momentum indicator back above the oversold threshold. Once the market triggers its turnaround, we’ll use the newly formed swing low to place our protective stop. Our first rule of trading must always remain risk management.
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