Gold Looks Like a 'Textbook' Short

Reading two linked charts on gold

Copper, Gold And Silver Bullion Manufacture At KGHM Polska Miedz SA Smelting Plant

Charts say short this shiny stuff.

Photographer: Bartek Sadowski/Bloomberg

Stay with me. 

Welles Wilder and George Kleinman matter. Both of them are among the must-read masters of technical analysis.

Welles Wilder was a giant of trend-based analysis: waiting to see the trend, getting on the trend, staying on the trend, and getting out of the trade without a lot of damage. My experience is that staying on the trend is the hardest part of the ballet with one gigantic exception: A cardinal rule is that you have to look at many, many, and many more trades to find a proper setup in which Wilder's work and Kleinman's moving averages mesh. Some are good, some are better than good, and some are textbook.

Gold, now, is a textbook trade.

Gold: a still life with five trend-based series. Three exponential moving averages, a trading envelope, and a parabolic SAR in a pear tree.
Gold: a still life with five trend-based series. Three exponential moving averages, a trading envelope, and a parabolic SAR in a pear tree.

This is the first of two linked charts on gold. Without killing you with details, the chart displays three interesting aspects of the action leading up to the date of July 7. The first blue arrow shows the first signal that gold is "well-behaved," as the nine-day Kleinman moving average "kisses" the 30-day average and turns south. I'm not brave enough to act (go short) there. The second blue arrow shows the two-day moving average breaking below the nine-day, which signals I should move out-of-cash and short-gold. I'm still not brave enough to act (go short). (Kleinman's use of moving averages is centered around how three series interplay. His standard model, seen here, is two-day, nine-day, and 30-day averages. I use exponential averages, which weigh more heavy more recent data.)

When do I act? When do you get the courage to enter a trade that risks your capital against the too-frequent pain of losing money when the trade goes against you?

The answer is July 7.

The red arrow signals that Tuesday, as described in the next chart. I assume I entered the short at the worst time (~$1,149 per ounce).

Gold: This is ADX/DMI with ADXR. 
Gold: This is ADX/DMI with ADXR. 

This chart is the same time frame, the red arrow is July 7. To the left, the buying energy is in green, and the selling energy in red. This study, on the left indicates what I call soup: a back and forth that can destroy capital as a stop-loss becomes many stop-big-additive-losses.

Then things change.

Gold rolls over, but I am afeared to act. I need "proof" that the trend has inertial force. The first sign is when the white line cuts up through the yellow ADXR line. (It's calculus-free July, so I will not go into the details. Read many articles and books on ADX/DMI theory. Here is a modicum of explanation: ADX/DMI studies show the interplay of buying and selling of, in this case, gold and combine a rate-of-change or first derivative study [ADX] and a 14-day approximation of the rate-of-the-rate-of-change or second derivative [ADXR].)

Then eureka! As the white line drives higher, it moves across the plunging green buying interest. I act because I have multiple signals that add to an inertial force, a belief in the probable outcome of the trade. I have diminished my likelihood of being wrong. Gold is beyond textbook. The above two charts rarely happen. The combination of many trend-based studies is elegant. The ADX/DMI chart is what you would teach to a class. As I enter the trade (at the worst point of July 7), I know I could see reversals. In hindsight, I'm golden. The selling interest picks up and critically, buying interest in gold evaporates. Note the leaden persistency of the green descending DMI line.

I am still in the trade but have respect for how far gold has descended. My short is "long in the tooth." There is much more to explain and judge by the day, but the recent collapse in gold gives us a rare opportunity to see a textbook trend-based ADX/DMI short.

Summary: Speculation is founded on not losing money. One protection is to be a slave to trends knowing you will be wrong a lot. Trend-based studies are not foolproof but provide discipline to lose less money, make some money, and, very rarely, make a lot of money. The key to this textbook trade is the combination of sequential trend studies with dynamic trend studies. Rarely do they line up so elegantly like gold at this moment.

Discuss, reading Welles Wilder and George Kleinman.

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