The price of gold opened 0.27 percent higher this morning, creating an upside gap. On the face of it, this would be considered a positive sign.
It means demand is outpacing supply, with buyers willing to up the ante in order to obtain additional contracts of the world’s original safe haven asset. Fundamentally, one would assume investors would be reluctant to reroute their capital out of havens and into risk assets at this particular moment. Indeed, Treasuries are also rising.
Nevertheless, from a technical standpoint, we see a red flag.
It may be that the second bullish session within a series of three sessions could soon result in a sharp reversal. Technically, the name of the pattern created by these three sessions is an Evening Doji Star. Today’s gap may therefore actually be an Exhaustion Gap, the last leg in a rally, signifying the final spark of demand.
From a technical perspective, other factors are also noteworthy. The price gapped up at the top of a channel, where supply has been outpacing demand, pushing prices back toward the bottom of the channel.
While the fundamentals for gold may not be clear, we have argued, regarding equities, that there may still be a bounce before the next leg in the downtrend, on signs that anyone who wanted to sell is already out at this point. This means investors could be sitting on cash that could potentially go back into risk-on assets, meaning equities, which would be a negative for gold. In fact, its RSI is the most oversold since the beginning of the year.
Case in point, the price of gold proceeded to tumble nearly 15% since the start of 2018. Of course, no two markets are the same—particularly not equities and gold. Equities were, at the beginning of the year, still very much in a bull market within an uptrend. Now, as the year ends, the NASDAQ and Russell 2000 are already in bear markets. The SPX is on the cusp.
We're not saying the activity in gold markets will be exactly the same, but a rebound in stocks, even short term, could still have an adverse effect on gold.
Trading Strategies
Conservative traders would wait for the price to return to the channel bottom and confirm its support, with at least one long, green candle engulfing a red or small candle of either color. The $1,235 level may be that point, the October-November resistance that turned to support in mid-December.
Moderate traders may risk a short, if the Evening Doji Star completes with a long red candle. The further it digs into the first, green candle’s real body, the more reliable the signal, but it should be at least halfway. As well, though it’s rare, if the red candle follows a falling gap, it would boost the signal’s potency. Still, at this point, it may not be a great trade from a risk-reward perspective. For a better entry, traders may wait for the price to retest the pattern’s resistance.
Aggressive traders may enter a short now, relying on the odds expressed by several, albeit inconclusive technical indicators and a very rich risk-reward ratio.
Aggressive Trade Sample:
- Entry: $1,272.50
- Stop-loss: $1,275, above today’s high
- Risk: $2.50
- Target: $1,250, psychological, round number above December’s resistance
- Reward: $22.50
- Risk-Reward Ratio: 1:9
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