Wednesday, January 8, 2014

GLD: It's still a bear chart

Gold has been very much a topic of market chatter in recent weeks.

"Gold Stocks: What To Expect In The New Year"

"Has Gold Entered a New Bull Market?"

"23 Reasons to Be Bullish on Gold"

When the happy talk (or sad talk) is raging, that's when the serious trader turns to the chart.

None of the potential trades from my ovenight analysis struck me as being worth a detailed look. Two potential bear plays, GME and DNDN, had the best charts in the group, and even those inspired little confidence.

So I'm turning to gold, which as the world knows has been in a tremendous downtrend since futures peaked at $1,923.70 on Sept. 6, 2011.

For this discussion, I'll use the gold exchange-traded fund GLD as an avatar for the metal. Its peak on that date was $185.85.

The Chart

In Elliott wave terms, I count GLD has tracing a A-wave to the downside, the first leg of a correction of the long rise from double digits.

The A wave will eventually be followed by a B-wave retracement to the upside, and then a C-wave downward that will make the previous downtrend look like an inconsequential stumble. That, at least, is the typical pattern.

Click on chart to enlarge.
GLD 3 years 2-day bars (left), 6-month 4-hour bars (right)
The present leg down began Aug. 28 from $138.17, and I've labelled it wave 5 {+1} in the right-hand chart. That wave, internally, is completing the leg of its decline, wave 3, and that third wave is nearing an end.

In these charts, I place GLD as being in wave 5 {-1} of 3 of 5 {+1} of A {+2}.

The lower right-hand corner on the right chart shows wave 5 {-1}, the last leg within wave 3, has far to go before it move past the end of wave 3 {-1}, as it must under Elliott wave rules. If it fails to achieve a lower low, then my count is incorrect.

That gives GLD at a minimum 3.3% of downside room, and there's no rule that says wave 5 {-1} must be cut short at that level. Usually, fifth waves continue on, often for a quite a long distance, before they run out of steam.

Wave 3 {-1} took about two months to complete. If wave 5 {-1} is proportionate -- and there's no rule requiring that it be -- it's decline will carry into early March.

Up two degrees of magnitude, wave 3 {+1} lasted nearly nine months, so a proportionate wave 5 {+1} would carry into May.

All of this simply suggests that there's room in both time and price for GLD to decline further, and for my count to be judged accurate, GLD must indeed decline below $114.03.

GLD last broke below its 20-day price channel on Dec. 19, when the lower boundary stood at $117.23. Since then it has spent a dozen days meandering like a drunken goldbug, with very little directional momentum to show for its efforts.

Indeed, the two completed bear signals of wave 5 {+1}, which began Aug. 28, 2013, split evenly, with the successful trade yielding 0.5% over 19 days, compared to a 1.3% loss over 28 days for the unsuccessful trade.

The resulting negative 0.8% yield spread shows that GLD hasn't produced reliable bear signals during this four-month period. The low yield on the winning trades shows that GLD's downside momentum lacks energy.

Things are better over the longer term. The entire period of the bear market, from Sept. 6, 2011, shows 10 completed bear signals. Seven were successful, for an average 4.6% yield over 36 days, compared to the unsuccessful trades' average loss of 1.7% over 20 days.

The resulting 2.9% win/lose yield spread is quite acceptable in my trading.

What that says is that GLD's glory days are behind it. both the reliability of its bear signals and magnitude of its downside momentum have lessened.

From that I conclude that the articles cited above, and their myriad cousins, are asking the wrong question. It's not, What will gold do in the next year. Rather, the proper question is, Can I make money between now and March.

Sometime in the next year, perhaps before summer, GLD may well complete its A wave to the downside and begin a B-wave retracement to the upside, savage the less nimble among the gold bears.

Between now and then, however, I see a chance to make some money as the A wave completes its work.

Liquidity and Volatility

GLD is highly liquid, with average volume of 3.8 million shares. It supports an awesome selection of option strike prices spaced $1 apart, with open interest running to four and five figures near the money. The at-the-money front-month bid/ask spread on puts is a narrow 3%.

Implied volatility stands at 19% and has been tracing a widely swinging sideways pattern since late October. It is in the 16th percentile of the three-month range, a low level that lends credence to debit options positions, such as bear put spreads.

Options are pricing in confidence that 68.2% of trades will fall between $111.54 and $124.66 over the next month, for a potential gain or loss of 5.6%, and between $114.95 and $121.25 over the next week.

Contracts are trading at a steady pace today, with calls running 24% above their five-day average volume and puts running at 77% of average volume.

Decision for My Account

Between the happy talk and the sad talk, color me sad. I see GLD has being in a clear bear trend that has time and distance to go before it runs its course.

Having said that, the nearer-term odds give me pause. I don't intend to enter into a new position in GLD until it again breaks below its 20-day price channel and confirms it by trading below the breakout level the next day. The present breakout level is $114.46

 I shall add GLD to my Watchlist to ensure I catch that breakout when it occurs.


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

I use the number 68.2% in using applied volatility to calculate the expected trading range. 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. The principal practitioner 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

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

See my post "Chart Analysis: Nomenclature" for an explanation of my method for labeling waves on the chart.

By preference I place my trades in the last half hour before the closing bell in New York. See my essay "When is the best time to trade" for a discussion of the practice.

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.

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