Thursday, August 15, 2013

GDX: Trends within trends

Update 8/29/2013: GDX fell below its 10-day price channel, a signal to close the position. After the break, it rose intraday and I was able to exit for a small loss. 

The shares never really followed through on their bull signal of Aug. 16, instead trading sideways. The decline began two days ago on Aug. 27, as the possibility of American intervention in Syria appeared to grow less imminent.

The position was structured as short vertical options spreads expiring Sept. 20 and sold for credit. Often in such cases I'll wait before closing a position. But the potential for loss was more than the potential for gain, so based on that risk/reward calculation, I gritted my teeth and swallowed the bitter pill.

During the 14 days I held the position, the shares declined by 1.5%, which works out to down 39.5% annualized.

This was one of those rare instances where the options outperformed the shares. The yield on risk of the vertical spreads was negative 0.8%, or negative 19.8% annualized. 

The Market Vectors Gold Miners exchange-traded fund (GDX), a favored vehicle for gold bugs, broke above its 20-day price channel on Wednesday and confirmed the bull signal today by trading above the breakout level and even, briefly, touching a new high, $28.90.

All vehicles for gold have been in a strong downtrend since September 2011, with the most recent leg down having begun in September 2012 from $55.25. The declined hit bottom at $22.56 on June 26 and reversed.

This is the second bull signal from GDX since the downtrend reversed. The first, on July 22, reversed two days later and signaled an exit for a 7.7% loss on Aug. 5.

The problem with gold is that it has been on the slide for so long, no one can believe that it may indeed be on the rise again, me among them. I nearly relegated GDX to a "Thursday: No Trade" posting, so unlikely the idea of an upside breakout in gold appear to be.

GDX was the lone symbol to survive my initial screening last night. (See "Thursday's Prospects".) I also penciled in a second symbol, GOOG, for further consideration because of its size and impact. However, the GOOG bear signal is so contrary to the stock's uptrend that I've turned away from it for now.

But back to gold.

GDX 90  days 1-hour bar
The question, as always for a trader, is how much fuel is left to power the present trend.

Elliott wave analysis counts GDX as being in a corrective zig-zag to the upside, running contrary to the broader downtrend. A zig-zag is three waves and the chart shows GDX has completed the first two.

The final wave, C, is composed of five sub-waves. I count two waves completed and a third underway.

By the rules, wave 3 cannot be the shorter than both wave 1  and wave 5. Wave 1 is $4.09 in length, and wave 3 started from $27.05, so either wave 3 will reach $31.15 at a minimum, or wave 5 will be shorter than wave 3.

In any event, wave 3 will be followed by a wave 4 correction and then a final push to new trend high in wave 5.

Those facts suggest to me that there is 2.4% potential to the upside, at a minimum, from today's close.

No guarantees, of course. Elliott wave counting is notoriously ambiguous. My count differs from the count on gold by the leading company of Elliotticians, who see less upside potential.

That's a long way of saying that it's possible to make bullish money even during a downtrend, as long as the trader understands the relative time levels of the two trends. Nothing stands alone in the markets. Every trend is part of a greater trend and envelopes a lesser trend.

The Gold Miners ETF is a composite of the largest gold mining companies, with a quarter of the fund's holdings in two: Goldcorp Inc. (GG) and Barrick Gold Corp. (ABX).

GDX on average trades 40 million shares a day and supports a truly awesome selection of option strike prices, many having open interest in the five figures. The options grid is a speculator's dream.

Implied volatility stands at 25%, at the top of the six-month range after a rise that began Aug. 12.

Options are pricing in confidence that 68.2% of trades will fall between $26.88 and $30.98 over the next month, for a potential gain or loss of 7.1%, and between $27.95 and $29.91 over the next week.

Trading today is close to normal, with calls running 7% above the five-day average volume and puts at 78% of average.

The fair-price zone on today's 30-minute chart runs from $28.42 to $28.90, encompassing 68.2% of transactions surrounding the most-traded price, $28.62. The price opened in the lower portion of the zone and stayed there for the first two hours of trading before pushing above the zone ceiling.

The Gold Miners ETF goes ex-dividend in December for an annual payout yielding 1.59% at today's prices.

Decision for my account: I like this trade, mainly based on the Elliott wave count. 

I've opened a bull position in GDX, structuring it as a vertical options spread expiring in September and sold for credit. The position is fairly low leverage, at 2:1. The maximum profit at expiration is 24%. The position provides a 9% hedge, meaning it is profitable if the price falls to 9% below entry at expiration.


My trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

At several points in my analysis I use the number 68.2%. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Elliott wave analysis tracks patterns in price movements. StockCharts has a good explainer. The principal practioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

No comments:

Post a Comment