Friday, July 2, 2010

Gold ETF: Time To Buy?

On Thursday, the SPDR Gold Trust (symbol: GLD), which is the ETF that tracks the performance of gold, saw its worst one day performance since February, 2010. No one would deny that gold is in a bull market, but does this sell off represent a buying opportunity?

Figure 1 is a weekly chart of the GLD, and the pink labeled bars are negative divergence bars. In this instance, the divergence is between price (i.e., what you see on the chart) and an oscillator (i.e., like a stochastic or RSI) that measures price. A negative divergence means that price is going higher but the oscillator is heading lower. As I have chronicled on many occasions in the past, negative divergences signify slowing upside momentum at best and often times lead to a range in prices where the highs and lows of the negative divergence bar serve as the highs and lows of that range. They are not a harbinger of a market top unless there is a clustering of negative divergence bars and more often in a bull market they lead to higher prices.

Figure 1. GLD/ weekly

This past week's price action is producing a negative divergence bar in GLD, and this mini sell off has many wondering if this represents a buying opportunity or not. So let's construct a simple study. We will use weekly data of the GLD and execute all trades at the close; commissions and slippage are not considered. The first trade generated was in February, 2006. The buy rule is: 1) buy GLD on a weekly close when there is a negative divergence bar. The sell rule is two fold: 1) sell GLD on a weekly close below the low of the negative divergence bar; or 2) sell GLD on a weekly close above the high of the negative divergence bar.

So looking at figure 1, we buy GLD when there is pink bar and sell our position on a weekly close above or below the highs or lows, respectively, of that pink labeled price bar. Simple enough. I have labeled the buy and sells from the trades generated from this strategy.

Since 2006, there were 13 trades generated by this strategy. 69% or 9 trades were winners. In other words, if a negative divergence was present, there was a 69% chance that prices would close above highs before closing below the lows of that negative divergence bar. But remember this is what one would expect when being in a bull market.

The maximum adverse excursion (MAE) graph for this strategy is shown in figure 2. The MAE graph assesses each trade from the strategy and determines how much a trade had to lose in percentage terms before being closed out for a winner or loser. You put on a trade and if you are like most traders the position will move against you. MAE measures how much you have to angst and squirm while you are in that position. As an example, look at the caret in figure 2 with the blue box around it. This one trade lost 3.25% (x-axis) before being closed out for a 3.5% winner (y-axis). We know this was a winning trade because it is a green caret.

Figure 2. MAE Graph

Looking at all the trades from this strategy, we note that the 3 out of the 4 losing trades had MAE's in excess of 3.5%; these are the trades to the right of the blue line. These trades did not recover, so in all likelihood, a trade that loses more than 3.5% will be a losing one.

Other characteristics of this strategy include: 1) average time in a trade was 3.5 weeks; 2) the ratio of average win to loss is 2.46; 3) the RINA index, which is a measure of trade efficiency or which takes into account profit, draw down and time in the market, is a very robust 214; above 50 is considered good.

In summary, gold is in a bull market. The weekly chart shows a negative divergence bar. Negative divergence bars signify slowing upside momentum; however, in a bull market it pays to buy those divergences.


Mike C said...

Is this enough of a dip or do we need to retest the 1160-1170 level which was the last reaction low and previous resistance

Bill said...

i had been following your blog for quite some time. some quick questions

1. does this strategy hold for other markets like spy and other etfs

2. rsi or other oscillators, do you use something like rsi(14) and if its moving up and price make a low that triggers a buy. please explain little more.

Guy M. Lerner said...


Good questions

1) generally it is a strategy that works best in a strong bull market - 1990's for equities for example

2)however, a clustering of negative divergences (i.e., greater than 3) generally is a market top in most assets I have looked at

2)I have not tested other oscillators but the oscillator I use is called value charts; I use it because I can program with it; I am not a big fan of oscillators anyway so there is nothing special here

A negative divergence occurs when price goes higher and the indicator goes lower. Another example would be the 10 day moving average of new highs - new lows; this is an oscillator; I don't follow this but I am sure at the recent market highs this indicator was less than the prior peak although price was other words, breadth was diverging (heading lower) while price was heading higher

ryanmburke19 said...

I am too cautious to short one of the only remaining bull markets. But when I look at previous gold corrections of import over the past few years, it seems as though almost every one began with a large one-day sell off like the one just seen.

I am considering shorting SLV given its shared characteristics with industrial metals, its lackluster performance relative to gold, and its overly bullish sentiment. I would like to see a bounce for a better entry, however.