Saturday, November 3, 2012

Dow Theory Special Issue: A second opportunity to get into Gold and Silver?

During all the ascent of gold and silver, I advised not to chase rising prices since, as the price goes higher, there is less money to be made when right and more money to be lost when wrong. This is why I wrote a post entitledWhat should I do if I missed the Dow Theory bull signals for the SPY and GLD? Dow Theory’s second chance: The first secondary reaction” which you should read if you want to fully understand this new post here

In that post I discussed the risk reward issues facing the latecomer and the early bird.

However, at present we are in the midst of the secondary reaction I alluded to in that post. So now latecomers may wonder whether they have been given the “Dow Theory’s second chance."

Should they jump aboard without further ado? Or should they still bide their time?

Yesterday, 11/02/2012, GLD closed at  162.60. SLV closed at 29.95.

As you know, the Dow Theory signaled a primary bull market in gold and silver on August 22, 2012.  It is a must that you acquaint yourself with the bull market signal by reading “August 22, 2012. Dow Theory signals a new primary bull movement in gold and silver?” which you can find here and here.

You need to understand why gold and silver are in a primary bull market to follow properly the rest of this post.

As you can read in the two posts, I have just mentioned, the primary bull market started on 5/16/2012.

No timing system can signal the onset of a new bull market in “real” time with no lag. Thus, the Dow Theory signaled the new primary bull market in gold and silver on August 22. If this sounds like an unacceptable lag to you, it is worth considering that moving averages (i.e. the 200/50  MA crossover) tend to show less responsiveness and greater lag. Thus, trust me; the Dow Theory did a pretty good job in signaling the existence of a new bull market in gold and silver.

The primary swing lasted until 10/04/2012. On this date, gold and silver made new highs. It is advisable that you read what I wrote on this day about gold and silver by clicking here.

Since that date, gold and silver entered a secondary reaction. Such secondary reaction was “detected” and signaled by the Dow Theory on 10/19/2012. You can find all the details as to such secondary reaction and, more importantly, how it is appraised here.

Here you have a chart that clearly illustrates what happened in the past and where we stand now:

Watch GLD and SLV like a hawk! The blue line defines the entry level on August 22
 So, to sum up, we know:

1)     Gold and silver are in a primary bull market. Such primary bull market was signaled by the Dow Theory on August 22.

2)     Early birds were supposed to buy gold and/or silver on such a day or the next day. Not later because as the price advances the risk reward of the trade deteriorates. This is why I never thought it was sensible to chase a trade. 

3)     The main primary bullish thrust lasted until Oct 4, 2012. Since that date gold and silver are caught in a secondary reaction. As I wrote yesterday we are seeing a normal secondary reaction.

4)     On Nov 2, GLD closed at  162.60. SLV closed at 29.95. Thus, current prices are very near from the original “entry” prices dictated by the Dow Theory on August 22 (160.54 for GLD and 28.92 for SLV) which renders a decent risk reward ratio again.

5)     We also know that most of the primary bull market signals end up with profits. We also know that profits from successful bull market signals are normally larger than losses stemming from failed bull market signals. This implies that the odds favor the resumption of the primary bullish trend.

As I wrote yesterday, we know that gold has retraced ca. 45% of the previous bull swing and silver 48%. If the secondary reaction stops here, we would have seen a typical secondary reaction. A retracement of 50% is fully normal. So maybe we are witnessing the last gasp of this reaction. However, we simply don’t know, and it may be possible that the correction is not over.

According to the Dow Theory, the market may continue to go down and continue to be in a primary bull market until the last recorded primary bear market lows are broken. In other words, we cannot exclude more downside movement.

So what should latecomers do? Close their eyes and buy gold and silver right now? I wouldn’t do it. There is a saying in trading that reads “Never catch a falling knife."  Both GLD and SLV have downward momentum, so the odds favor a continuation of the bearish thrust. Of course, this is not carved in stone, and maybe we have just witnessed the last gasp of this secondary reaction. However, I am highly influenced by odds and probabilities, and I do know that momentum favors the downside and since the secondary reaction is currently just “average," it has still statistical likelihood to go further down.

Furthermore, as you can see in the chart (blue horizontal lines) prices are still somewhat higher than the original entry prices on August 22.

For me, one thing is clear: the best chance to get “aboard” is the first chance, namely the day (or next day at the open) when a Dow Theory bull signal is displayed. Therefore, if I were a latecomer, I wouldn’t enter at a worse price. I try my emotions never to interfere with cold facts. I rather prefer to miss an opportunity than “force” a trade or investment. Better safe than sorry.

So, personally, what I’d do, if I were a latecomer, is as follows:

1)     I’d divide the funds intended for precious metals in half. In case of doubt, I’d buy a little bit more silver since it is the strongest metal.

2)     I’d wait until gold goes down to the original August 22 entry price of 160.54 for GLD. For silver I’d wait until prices go down to 28.92 for SLV.

3)     If you look at the figures I publish every day, you will see that by entering at such prices you stop-loss are located 7,41% below your entry price for GLD and 12.84% for Silver. Such stop-losses are the last registered bear market lows. Any other stop is technically defective and has a great likelihood of being run. If you cannot afford to lose 7.41% (GLD) or 12.84 (SLV), then you should commit a smaller amount to find your comfort level. However, don’t raise your stops. Under Dow Theory narrower stops would be defective. 

4)     The likely reward is ca. 40% for gold (if this is a real primary bull market and last 1-2 years) and ca. 80% for silver given its greater volatility.

5)     If you buy GLD or SLV or any other gold or silver ETF you have to know the animal you are dealing with and what your timeframe is. I encourage you to read my post “Not all “gold” is born equal. Gold and the Dow Theory” which you can find here.
6)    Finally, you have to bear in mind that this is an investment whose time horizon rarely exceeds two years. However, this is not a day trade either.


The Dow Theorist. 

Disclaimer: Dow Theory Investment and its author is not a financial adviser. Dow Theory Investment and its author does not offer recommendations or personal investment advice to any specific person for any particular purpose. Please consult your own investment adviser and do your own due diligence before making any investment decisions. Please read the full disclaimer at the bottom of the footer of this blog.

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