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Few commodities generate as much emotion as gold.
Whenever the precious metal breaks out, the gold bugs dive in, hoping to generate big wins.
And this year has been no different. The higher the gold price rallied, the more speculators got pulled into the trade.
But as we discussed last week, gold has a habit of reversing sharply. And that can lead to disappointment.
That’s why I trade gold differently… I prefer to trade gold’s reversals for rapid profits.
We did so this past week…
The SPDR Gold Shares ETF (GLD) recently retraced from its late-October high. So we looked to capture a bounce when that down move became overstretched.
Altogether, we generated a blended 36.3% return in just four days for subscribers of The Opportunistic Trader. (And that included a weekend.)
So today, I want to show how we did it…
Reversal Pattern
You can see the tail-end of GLD’s yearlong uptrend in the chart below. That move peaked and turned around with a common reversal pattern.
SPDR Gold Shares ETF (GLD)
Source: e-Signal
When the Relative Strength Index (RSI) and the stock price diverge like this (orange lines), it often precedes a reversal.
That’s because steadily falling momentum will eventually pull a stock lower…
Donald Trump’s win compounded that down move. His proposed policies caused the U.S. dollar to soar. And a strong dollar typically leads to a weaker gold price.
But like any other move, a sell-off can go too far too quickly. That makes the stock vulnerable to a reversal.
And that’s what I was looking for here…
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The RSI had fallen from overbought territory (upper gray dashed line) to near oversold territory (lower gray dashed line). We wanted to take advantage of a mean reversion trade to the upside.
Remember, mean reversion is like pulling on a rubber band. If you stretch it too far in one direction, it wants to snap back to neutral. Stocks can behave the same way.
So we entered a long position on GLD by buying a call option. A call option increases in value when the underlying stock rises.
And as the chart shows, that proved to be the right call…
Take another look:
SPDR Gold Shares ETF (GLD)
Source: e-Signal
An upswing in momentum (red circle) caused GLD to gap higher.
Four days later, we decided to lock in some profits by exiting half our position for a 31.9% gain.
We kept the remainder of our position open in case GLD continued to rise.
Happily, GLD kept rallying that same day. So we closed out the remainder of our position for a 40.7% gain.
That equated to a blended 36.3% gain in just four days.
Keep in mind, we generated this return in such a short period by trading options. Options magnify both wins and losses.
Options have a finite life, so you’ve got to get the move you’re looking for before your contract expires in order to profit.
But this trade shows the beauty of trading options.
Having waited for the right setup, we bought a call option to profit from a potential bounce. We then sold it a short time later for a handy profit.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict