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The Real Price of Silver, 1344-1998 (1998 Dollars)

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Written by Classic Chartist

October 28, 2011 at 6:19 PM

Posted in Technical Trading

Silver’s 2nd Most Oversold Reading in a Decade

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By Chris Puplava

But Parallels of 2008 Still Suggest Caution

Silver (SLV) just completed its second major correction this year after its parabolic rise and peak in April. The second decline that occurred over the last month has led silver to shedding nearly half its value. The decline over the last six months has pushed our silver indicator to the second most oversold value in a decade. Is this a major buying opportunity or are investors now catching a falling knife? The answer to that question hinges on what the dollar (UUP) does over the next several weeks.

Silver Deeply Oversold

Given the sharp selloff in silver over the last few months it’s not surprising to see silver in oversold territory, but how oversold is it relative to prior corrections? To show how extreme silver’s recent oversold condition is, our silver risk indicator below shows that silver is at its second most oversold reading in the past decade, with 2008 the only exception. Quite the whipsaw after our indicator showed the most overbought condition in silver in April, with our silver indicator exceeding the 2004, 2006, and 2008 peaks, and then to see the second most oversold reading six months later. Given the deeply oversold condition silver finds itself in, is now a good time to take advantage of the recent price decline? Yes and no.

silver
Source: Bloomberg

If you compare the average path of the 2004, 2006, and 2008 corrections we should be putting in the final low for silver here and we could witness a sizable Q4 advance that sees silver rally north of $45/oz. My silver correction composite below suggests silver may trade sideways into middle October as it puts in a bottom before making a sizable run heading into the end of November. That said, I would recommend against throwing caution to the wind and scooping up silver right here.

silver corrections
Source: Bloomberg

2008 Analog May Hold the Key

Looking at the most recent major correction in silver, the 2008 top, suggests some caution as of the three prior major corrections (04, 06, 08), the 2008 correction shows the closest resemblance to silver’s 2011 correction. As shown below, if silver continues to trace out its 2008 top, it may embark on a further correction beginning next week that could take it to the low $20/oz level heading into November.

silver 2010 vs 2008 top
Source: Bloomberg

What makes watching silver over the next week or so incredibly important to its performance for the rest of the year is that the 2008 analog is holding quite strongly across other asset classes and thus stresses caution for precious metal investors as I suggested earlier in the year (Echoes of 2008 Suggest Caution for Precious Metals Investors). For example, the S&P 500 (SPY) is tracing out its late 2007 to early 2008 top in virtually identical fashion and suggests the stock market may get a bid into year-end as it works off its oversold condition.

s&p
Source: Bloomberg

All Eyes on the USD

But more importantly to silver and precious metal investors is that the USD is tracing out a similar path to what transpired over 2008. If the 2008 analog holds, we are likely to witness a short-term top in the USD and then a surge heading into the end of this year.

dollar usd
Source: Bloomberg

Looking at the global strength of the dollar tends to confirm a short-term top is likely forming. Below is a table of foreign currency returns relative to the USD over various time frames. As seen in the left two columns, foreign currencies are firming relative to the dollar on a short-term basis and likely hint of a temporary pause. However, the last four columns show the USD has been strong against nearly every world currency except for the Yen, Chinese Renminbi, and the Thai Baht. This suggests that the low put in by the dollar over the summer was a solid low from which it should stage a cyclical bull market rally in the context of its 2001-present secular bear market.


Source: Bloomberg

The likely catalyst for the dollar’s rally—as with the 2008 advance—is that the global economy is slowing (see World Economy Hanging By a Thread) in which foreign central banks are likely to cut interest rates to revive their economies. When foreign central banks cut rates relative to US short-term interest rates, it makes foreign currencies less attractive as the interest rate differential with US rates falls. The USD’s advance in 2008 was discounting the foreign central bank rate cuts to come and the current advance in the USD is likely doing the same as the deceleration in global growth is likely to ellicit central bank rate cuts ahead.

usd rate spread
Source: Bloomberg

If the USD is to continue its advance after it cools off for a bit, we are likely to see preciousmetals continue to selloff or trade flat at best, and thus give silver some time to prove itself before throwing caution to the wind and trying to bottom tick buying silver. The key will be to watch how the dollar performs in the weeks and months ahead. Right now, the USD Index is above its 200 day moving average (200d MA) as well as its 50d MA, both of which are converging near $76 and would represent strong support on a short term correction in the USD Index. For the all clear to be signalled for silver, we would likely need to see the USD Index break below $76. As long as the USD remains above its 200d MA I think playing defense for precious metals is the proper strategy.

usd chart
Source: StockCharts.com

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Written by Classic Chartist

October 11, 2011 at 1:17 PM

Posted in Technical Trading

Commodity and Stock Rallies, in Elliott Wave Terms

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Commodities, in Elliott wave terms, tend to see their most explosive action in fifth waves — unlike stocks, where it’s third waves that are most powerful. Here’s why: Stock rallies are driven by greed. Commodity rallies are driven by fear, and fear gets stronger as prices get higher.

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Written by Classic Chartist

August 12, 2011 at 3:18 PM

Posted in Technical Trading

Why NOT to Rely on News Headlines for Stock Market Direction

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On August 3, the DJIA opened higher. The financial news media quickly explained why:

“Stocks gained at the open Wednesday…after a reading on private sector employment came in stronger than expected.”

That makes sense, doesn’t it? U.S. employment situation brightened, so stocks went up. Except that, minutes later, the Dow reversed and fell.

Nothing changed regarding the “better-than-expected” employment figures. No other negative news had come out. And yet barely an hour after the open, the Dow was lower by 140 points.

The financial news just as quickly caught up to the reversal:

 “…markets were down early Wednesday…with some mixed signals coming from the United States’ labour market.”

“US stocks slipped lower…as investors continued to digest the recent days’ fiscal debates, weighing some signs of hiring in the US against ongoing uncertainty… ”

So, the “better-than-expected” U.S. employment picture suddenly wasn’t so bright? Plus “the ongoing fears” kicked in? Again, this sounds reasonable, except…

…Except that you can now see how this type of “market forecasting” works. Here’s the recipe:

Step 1: Take any day’s news pile, the good and the bad.

Step 2: Look at what the stock market is doing.

Step 3: If stocks are up, name a few “good news” items and attribute the rally to them.

Step 4: If stocks suddenly turn down, focus on the “bad news” instead. And if there is none, look for a fly in the ointment inside the “good news” stories.

This model works well — that is, if you want the markets explained in retrospect. But if you want to know what stocks may do tomorrow, the conventional model has little forecasting value.

There is an alternative, using the Elliot Wave Principle. It had nothing to do with the news, only with the stock market’s objective Elliott wave patterns.

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Written by Classic Chartist

August 4, 2011 at 3:31 PM

Posted in Technical Trading

Five Fatal Flaws of Trading

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Close to ninety percent of all traders lose money. The remaining ten percent somehow manage to either break even or even turn a profit – and more importantly, do it consistently. How do they do that?

That’s an age-old question. While there is no magic formula, one of Elliott Wave International’s senior instructors Jeffrey Kennedy has identified five fundamental flaws that, in his opinion, stop most traders from being consistently successful. We don’t claim to have found The Holy Grail of trading here, but sometimes a single idea can change a person’s life. Maybe you’ll find one in Jeffrey’s take on trading? We sincerely hope so.

Why Do Traders Lose?

If you’ve been trading for a long time, you no doubt have felt that a monstrous, invisible hand sometimes reaches into your trading account and takes out money. It doesn’t seem to matter how many books you buy, how many seminars you attend or how many hours you spend analyzing price charts, you just can’t seem to prevent that invisible hand from depleting your trading account funds.

Which brings us to the question: Why do traders lose? Or maybe we should ask, ‘How do you stop the Hand?’ Whether you are a seasoned professional or just thinking about opening your first trading account, the ability to stop the Hand is proportional to how well you understand and overcome the Five Fatal Flaws of trading. For each fatal flaw represents a finger on the invisible hand that wreaks havoc with your trading account.

Fatal Flaw No. 1 – Lack of Methodology

If you aim to be a consistently successful trader, then you must have a defined trading methodology, which is simply a clear and concise way of looking at markets. Guessing or going by gut instinct won’t work over the long run. If you don’t have a defined trading methodology, then you don’t have a way to know what constitutes a buy or sell signal. Moreover, you can’t even consistently correctly identify the trend.

How to overcome this fatal flaw? Answer: Write down your methodology. Define in writing what your analytical tools are and, more importantly, how you use them. It doesn’t matter whether you use the Wave Principle, Point and Figure charts, Stochastics, RSI or a combination of all of the above. What does matter is that you actually take the effort to define it (i.e., what constitutes a buy, a sell, your trailing stop and instructions on exiting a position). And the best hint I can give you regarding developing a defined trading methodology is this: If you can’t fit it on the back of a business card, it’s probably too complicated.

Fatal Flaw No. 2 – Lack of Discipline

When you have clearly outlined and identified your trading methodology, then you must have the discipline to follow your system. A Lack of Discipline in this regard is the second fatal flaw. If the way you view a price chart or evaluate a potential trade setup is different from how you did it a month ago, then you have either not identified your methodology or you lack the discipline to follow the methodology you have identified. The formula for success is to consistently apply a proven methodology. So the best advice I can give you to overcome a lack of discipline is to define a trading methodology that works best for you and follow it religiously.

Fatal Flaw No. 3 – Unrealistic Expectations

Between you and me, nothing makes me angrier than those commercials that say something like, “…$5,000 properly positioned in Natural Gas can give you returns of over $40,000…” Advertisements like this are a disservice to the financial industry as a whole and end up costing uneducated investors a lot more than $5,000. In addition, they help to create the third fatal flaw: Unrealistic Expectations.

Yes, it is possible to experience above-average returns trading your own account. However, it’s difficult to do it without taking on above-average risk. So what is a realistic return to shoot for in your first year as a trader – 50%, 100%, 200%? Whoa, let’s rein in those unrealistic expectations. In my opinion, the goal for every trader their first year out should be not to lose money. In other words, shoot for a 0% return your first year. If you can manage that, then in year two, try to beat the Dow or the S&P. These goals may not be flashy but they are realistic, and if you can learn to live with them – and achieve them – you will fend off the Hand.

Fatal Flaw No. 4 – Lack of Patience

The fourth finger of the invisible hand that robs your trading account is Lack of Patience. I forget where, but I once read that markets trend only 20% of the time, and, from my experience, I would say that this is an accurate statement. So think about it, the other 80% of the time the markets are not trending in one clear direction.

That may explain why I believe that for any given time frame, there are only two or three really good trading opportunities. For example, if you’re a long-term trader, there are typically only two or three compelling tradable moves in a market during any given year. Similarly, if you are a short-term trader, there are only two or three high-quality trade setups in a given week.

All too often, because trading is inherently exciting (and anything involving money usually is exciting), it’s easy to feel like you’re missing the party if you don’t trade a lot. As a result, you start taking trade setups of lesser and lesser quality and begin to over-trade.

How do you overcome this lack of patience? The advice I have found to be most valuable is to remind yourself that every week, there is another trade-of-the-year. In other words, don’t worry about missing an opportunity today, because there will be another one tomorrow, next week and next month … I promise.

I remember a line from a movie (either Sergeant York with Gary Cooper or The Patriot with Mel Gibson) in which one character gives advice to another on how to shoot a rifle: ‘Aim small, miss small.’ I offer the same advice in this new context. To aim small requires patience. So be patient, and you’ll miss small.”

Fatal Flaw No. 5 – Lack of Money Management

The final fatal flaw to overcome as a trader is a Lack of Money Management, and this topic deserves more than just a few paragraphs, because money management encompasses risk/reward analysis, probability of success and failure, protective stops and so much more. Even so, I would like to address the subject of money management with a focus on risk as a function of portfolio size.

Now the big boys (i.e., the professional traders) tend to limit their risk on any given position to 1% – 3% of their portfolio. If we apply this rule to ourselves, then for every $5,000 we have in our trading account, we can risk only $50-$150 on any given trade. Stocks might be a little different, but a $50 stop in Corn, which is one point, is simply too tight a stop, especially when the 10-day average trading range in Corn recently has been more than 10 points. A more plausible stop might be five points or 10, in which case, depending on what percentage of your total portfolio you want to risk, you would need an account size between $15,000 and $50,000.

Simply put, I believe that many traders begin to trade either under-funded or without sufficient capital in their trading account to trade the markets they choose to trade. And that doesn’t even address the size that they trade (i.e., multiple contracts).

To overcome this fatal flaw, let me expand on the logic from the ‘aim small, miss small’ movie line. If you have a small trading account, then trade small. You can accomplish this by trading fewer contracts, or trading e-mini contracts or even stocks. Bottom line, on your way to becoming a consistently successful trader, you must realize that one key is longevity. If your risk on any given position is relatively small, then you can weather the rough spots. Conversely, if you risk 25% of your portfolio on each trade, after four consecutive losers, you’re out all together.

Break the Hand’s Grip

Trading successfully is not easy. It’s hard work … damn hard. And if anyone leads you to believe otherwise, run the other way, and fast. But this hard work can be rewarding, above-average gains are possible and the sense of satisfaction one feels after a few nice trades is absolutely priceless. To get to that point, though, you must first break the fingers of the Hand that is holding you back and stealing money from your trading account. I can guarantee that if you attend to the five fatal flaws I’ve outlined, you won’t be caught red-handed stealing from your own account.

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Written by Classic Chartist

June 23, 2011 at 7:51 AM

Posted in Technical Trading