Patience to wait for technical confirmation is critical to success.

- Chad Butler

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June 15, 2007

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Today’s article will focus specifically on the Gold market, in the scope of this larger cycle. Since this article would not provide enough space for us to dissect this market based on fundamental analysis, we will focus primarily on a technical analysis approach. By doing so, I think this offers a little something for everyone -- gold traders, market technicians, trend followers, and maybe even a little something for the fundamentalists and market psychologists.

A mere matter of months ago, everyone was clamoring to get on board the Gold train. Then, without warning, the market made a hard break and took out many weak longs with it. So, where are we now? Should you go with the longer-term trend and buy dips? Or is it prudent to be selling rallies?

Well, some of that depends on you as a trader. But after last week’s action, I think we have technical confirmation that we can consider trading this market to short side. We know that the trend is our friend until the end, and it might be quite possible that we have seen that end.

Before we can trade this market, we need to determine the trend (so we aren’t on the wrong side of it). I like to do that using some simple moving averages and a moving average convergence/divergence (MACD) that complements those moving averages (MA). To me, the relationship between the 9 period and 50 period simple moving averages is key to determining trends on daily, weekly, and monthly charts -- and for long-term trend trading, the relationship between these three time periods is also key.

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Beginning with the August contract, let’s look at the 9MA and the 50MA on the daily. The 9MA (representing the short-term money pressure on the market) is currently below the 50MA (which represents the long-term money pressure). This situation by itself is bearish.

To view the Daily Gold chart, go here.
Chart © Copyright 2007 FutureSource

I also consider the 20 period Exponential Moving Average (EMA), which gives more weight to recent days’ activities than those further in the past. In the case of the daily chart, we had recaptured the 20EMA two weeks ago -- an important technical level -- but failed to hold that area. That is bearish. Additionally, the MACD has recrossed to a bearish stance, confirming that the momentum is to the downside.

We do need to stop and review the longer-term picture. If we are looking to enter the market in a trend-following trade, we need to know if we are in line with the longer-term trend. To do that, I look at the weekly chart.

To view the Weekly Gold chart, go here.
Chart © Copyright 2007 FutureSource

One key thing we notice on the weekly is that the 9/50 MA relationship is bullish (the 9 period MA is above the 50 period MA). But this momentum is weakening, as indicated by the MACD, and we have failed to hold the 20EMA. Since the daily chart indicates that the market is looking to test lower areas of support, we can find some of those areas on the weekly chart. If we settle below 640.20 (the 50MA on the weekly chart), the market should be set up to test the 600-610 area and a failure there should set up a move to 580.

If you read my material released two weeks ago, you might recall that I was still bullish gold, but was looking for technical confirmation before entry. Here it is in case you missed it:

I would like to see the market close above the high of 6/1/2007 when we recaptured the 20EMA. That would mean a settlement above 677.50. That should set up a test of the 50MA and possibly the high of the current range in the 705 area. Trading to 705 would definitely pull our 9/50MA relationship bullish, and a breakout above that should set up further buying. ...Let the market determine your stop. ...Some key areas I would look at would be 657.50 and 647.20.

We never did get that confirmation (settlement above 677.50) and we took out the first support area to the downside. I want to point out that this emphasizes the importance of technical confirmation in a well defined trading plan. You cannot just jump in head first into a market without this critical step. You must exercise patience and restraint.

So, a shift to the downside is in order. If you are not already short, a settlement below 647.50 sets up additional entry areas. A word of caution -- this is still a very volatile market. Only use the futures if you are well capitalized and can handle the risk. Otherwise, consider an option spread strategy that would give you a more defined risk.

THE RISK OF LOSS IN TRADING FUTURES AND OPTIONS CAN BE SUBSTANTIAL. YOU SHOULD THEREFORE CAREFULLY CONSIDER WHETHER TRADING FUTURES AND OPTIONS FITS WITH YOUR INVESTMENT OBJECTIVES.

Chad Butler is a Senior Market Strategist with R.J. O'Brien. His market experience includes option spread trading, diversified trend following, and development of a number of index arbitrage programs. Chad's published work appears in McGraw-Hill's Complete Guide to Single Stock Futures, SFO Magazine, and other trade publications. He currently writes market research for RJOFutures and has been a featured seminar speaker teaching his various trading techniques to audiences large and small.

Get your complimentary Intro to Technical Analysis Guide from RJOFutures! This valuable tool could give you an edge in trading by helping you interpret the most common chart patterns for identifying market direction and target prices.