For Something A Bit Different: Trading Gold
Posted by The Diatribe Guy on January 15, 2010
Some of you know that I have been dabbling into the FOREX markets. I’ve now been at it close to a year, and this is a really interesting and potentially risky market. I’ve tried a few things that burned money quite fast, I’ve tried a few things that worked for a while but not all the time, and I’ve had a number of things I’ve wanted to try, but needed a programmed trading robot to do it and don’t have the expertise to write anything overly complex.
Some of the things that seem to work take an awful lot of time, and are still fairly risky.
It’s been a lot of fun. But lately, I’ve settled on a trading strategy that takes very minimal effort, and is much more of a longer-term investment trading strategy. I thought I’d share it with you.
Let’s start by taking a look at the current Gold chart, as seen on the MetaTrader 4 Trading platform:
As you can see, Gold is up around $1130/oz. It reached its peak up above $1220, but has been in a general uptrend for a couple years now, from levels under $700/oz.
My general strategy is to trade very, very small lot sizes, called micro-lots. Since gold is a commodity that has value, I only go long (buy, hoping price goes up). I buy on dips. I have no stop loss, meaning that if the price of gold drops, I just ride it out.
What this means is, I need to have enough money to absorb potential sizeable losses (the idea being this will be only for a time, and that eventually the price of gold will increase.) This is a LONG TERM strategy. You can take profits in the short term, and I do. I take some profits at some point every week. But when gold dips, I’m in a loss position on paper. You need to have enough money in your account to absorb this.
Here’s the basic idea:
Each micro lot controls an oz of gold. While you are technically “buying” the gold, you really are just controlling a contract. The broker sets aside a margin requirement to allow control of this ounce of gold, but it’s not like you have just frozen $1130. You have only frozen a fraction of this. So, it is highly leverages (100:1 or 200:1, usually). This is where people can get into serious trouble. Because they can really load up on the gold, but if the position goes against you the leverage kills you.
That’s why I buy in at microlots. 0.01 lots means that a $1 uptick in gold price adds $1 to my equity. I can set aside a few thousand dollars and realistically control a number of ounces of gold and be pretty comfortable.
I buy in at $10 dips, after a certain drawdown from the high. What I mean by this is that Gold reached a $1220 peak in round numbers. When gold dropped to $1170, I bought in at a microlot. Then, at $1160, I bought another. And so on. As equity increases, I’ll scale in at higher microlots as I feel I’m protected against large downswings. Right now, I want enough cash to absorb a drop to $900 in price. I don’t have that much, so I’m being a little risky, but if I really needed to I could transfer funds over. The lower the price, the higher I set my profit goal. For a purchast at $1170, I’ll close the position if it hits $1195. For the $1160 price, I’ll close it at $1187.50. Every $10 drop in buy-in drops my profit target price by $7.50. This is because I anticipate a larger upswing the lower price goes.
Here’s the key, though. Even if gold drops, I can still decide to take profits within the price range it’s currently trading in. So even if my buy in at $1170 isn’t touched again for 2 years, of price bounces around between $1000 and $1050, I’ll be taking profits. I re-evaluate profit taking goals all the time to make sure I have a good balance between some aggressive goals and banking profits. So, I may have a profit target of $40, but if price seems to stagnate at a profit of $25, I’ll take it and then just enter a new order at the old buy-in point.
As long as you are willing to ride out downturns and wait for the day where you see gold rebound in price, this strategy will yield guaranteed profit, and the overall rate of return will ultimately be quite high.
Here’s the HOWEVER, part: You ABSOLUTELY MUST have enough cash to cushion your account with to protect against downturns. Slow and steady downturns are less of an issue than sudden, steep drops. Do not take chances on getting margin calls. If you don’t have enough cash to trade every $10 dip, then do the math and figure out the right spacing and lot sizes for you. This is the one, single, but not-to-be-overlooked risk of trading without a stop loss. And that’s why you simply cannot trade large lot sizes regardless of where you think the market is going.
A more aggressive trader would take positions both short and long. You could absolutely do that, though I would recommend doing that on other currencies that seem to bounce around over time within a defined range. Gold being a commodity that will likely continue over time to increase in value, I don’t like a short position, except for maybe when it hits new highs. Even then, I’ll just wait for the dip and go long. If you want to try this kind of a strategy on other currency pairs, I’d personally recommend AUD/NZD and EURCHF. Again, start with microlots, and look at the history to figure out the possible range of maximum drawdowns so you know how much you need to set aside to absorb it.
This is not a Get-rich-quick strategy. You are basically investing in gold here, while allowing a very fluid way of getting in and out of the market to cash in profits when the profit is there. When it is not, you’re simply “holding your coins” and waiting for the day a profit comes again.
I like this strategy on an actual asset, but I’m much more wary about it against another currency. Anything can happen there. Gold has intrinsic value which makes it different from trading against a Euro or British Pound.
I’d be happy to clarify any points if anyone is interested.