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Gold is one of those assets that are not very well understood by retail traders. It is a commodity asset and is usually found on forex platforms as a Contracts-for-Difference (CFD) asset. This article will describe a simple gold trading strategy which can be profitable for the trader if applied correctly.
Before You Trade Gold: What You Must Know
Gold is not like the currency pairs you may be familiar with in terms of character, fundamentals and contract specifications. Before anyone decides to trade gold, that individual must take some time to understand gold and what trading this asset will involve.
Gold is principally a safe-haven asset: it is used for capital preservation when there is upheaval or uncertainty in other financial markets. This is shown by the nascent behavior of gold prices between 1980 and 2007, and its price explosion after the global financial crisis of 2008.
What Moves Gold Prices?
Gold has a unique set of fundamentals. It does not respond to conventional fundamentals of demand and supply as it has no industry-based economy. Most of the mined gold is used for jewelry and investment. It is the “risk-on, risk-off” sentiment of market traders that principally affect the prices of gold. Gold therefore responds to the following fundamentals:
- US interest rates
- USD dollar value
- Risk-on/off sentiment
Interest rates govern the rates of return of fixed income investments such as bonds as well as the returns on deposits. Low interest rates dampen returns on treasuries/bonds and money deposits, so focus of traders usually shifts to safe-haven assets such as gold. This leads to a buying demand and rising gold prices. Once interest rates start to rise, bonds and alternative investments that revolve around interest will become more attractive and focus will shift away from gold, leading to reduced demand and falling prices.
Gold has also been found over time to have an inverse relationship with the value of the US Dollar. Of course, a rise in US interest rates will spur demand for US Treasuries, and any foreign investment in US Treasuries will require buying the US Dollar to finance the transactions. So naturally, you would expect gold and the US dollar to move in opposite directions.
The “risk-on/risk-off” sentiment refers to traders either wanting to trade more volatile markets when the focus is to produce profits (risk-on), or to move away from risky assets when there is a lot of uncertainty into safe-haven assets such as gold, in order to preserve capital (risk-off). As a trader, you need to watch the news and study the global stock markets to understand when there is a risk-on or risk-off sentiment. We saw this at work as recently as this past week, where gold prices soared on news of the lowest economic growth China has seen in 28 years.
US interest rates, the value of the US Dollar as well as the risk-on/risk-off sentiment in the market are all fundamental influences on gold prices. Developing a trading strategy around these influences when they are at play in the market is the next line of action.
Gold Trading Strategy
One strategy which traders can use to trade gold is by using one of the oscillator trading signals. In this example, we shall explore the use of the break of the highs of the RSI, volume information and a breakout situation on gold in response to market news as signals for our trade.
We see that gold prices found a resistance at $1,285. However, news from China showing that the rate of growth of the Chinese economy was the slowest it has been in many years, spurred a risk-off sentiment in the market, leading to a fall in global stocks and a safe-haven demand for gold.
Also Read: Top Gold Trading Brokers
We can see the sharp rise in buying volume, showing great demand. Once the candle pushed and closed above the resistance line, accompanied by a break of the RSI highs, the upward move was on. A buy entry on the close of this candle at $1,288 would see the position in profit territory.
Trade Entry and Exit
What are the proper parameters for trade entry/exit as well as risk management?
In many cases, price tends to pull back to its broken key levels. However, if the volume is high, this is a sign that there is a lot of demand and there may be no pull back. This is what happened here; the very sharp rise in buying demand indicated that prices would keep going up without looking back. So the entry would need to be made once the breakout candle has achieved a 3% penetration of the resistance line.
The exit point of any trade should be at least twice the distance between the entry point and the stop loss. Furthermore, exit points should not be set at random, but should be done using previous support/resistance levels as the landmarks. For this trade example, the previous resistance lies at $1,309, which was last seen in May 2018. So the trade still has some strength left in it before it hits a wall. Never be tempted to do what many retail traders do: setting their exit points at random and in a very generous manner, without considering previous support/resistance areas.
- Risk Management
Gold trading is expensive business. Margin requirements are much higher than in the forex market, and the spread is also very high: between 40 pips and 80 pips in some cases. Therefore, your account needs to be well capitalized if there is any chance of managing the risks involved. 3% of the account capital is the maximum capital exposure that traders should adhere to. Anything beyond that, in the presence of a losing streak, will put the account in jeopardy.
Practice using this trade setup on your own to see how it works out for you.
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