January 8, 2015
Time to Exploit This 4:1
Reward/Risk Gold Trade
By Michael Kahn
Picking a bottom in any market is tricky, but trading is not about being right 100% of the time. It is about finding trades with good reward/risk profiles and exploiting them. As the lottery ad says, "You gotta be in it to win it."
Thankfully, technical analysis means we have immensely better odds of profiting than anyone playing the lotto.
The gold market has been a widow maker for the past few years, as legions of bottom fishers have tried and failed to catch a falling knife. But now, gold mining stocks seem to be quite resilient and some are even bucking the trend in the U.S. dollar.
Gold and most commodities are priced in dollars, and that means a strong buck is not good for those real assets. Gold and the stocks of companies that mine it should be falling as the U.S. dollar index reaches nine-year highs in a rocket ship trajectory.
Yet, while most gold mining stocks and funds are still in declining trends, some, including the Market Vectors Junior Gold Miners ETF (NYSE: GDXJ), appear to be transitioning to a more bullish posture.
Focusing on the most recent leg down, from July to December, the ETF moved from roughly $45 to $22. However, its December low, while below its prior low in November, was accompanied by strengthening technicals.
For example, momentum, as measured by the Moving Average Convergence/Divergence (MACD) indicator, sported a higher low. This divergence between price and momentum indicator forecasts a possible bullish change in trend.
Further, GDXJ closed the past three consecutive days above its key 50-day moving average for the first time since August. This is another sign that the winds of change are blowing.
Sentiment for the metal itself is still rather dour, but that could turn out to be a positive. Sentiment is bearish enough to suggest "everyone" is leaning one way, and the market rarely accommodates a super majority view.
To be sure, there are hurdles ahead. These include the November high in the $29 area. In fact, trading since October left a possible double-bottom pattern on the chart with the November high as the center peak of the "W" shape. A move above $29 would likely convince the bears to abandon ship and really soup up the recovery.
But for now, we are looking at a good reward/risk for early traders who understand the risks inherent in looking for a tradable bottom.
I want to emphasize that I am not calling for "the" bottom in gold or a new bull market. But the potential gain for successfully riding a return to GDXJ's 200-day moving average near $35 cannot be ignored. Placing a stop-loss 7% below the current price, our reward/risk is nearly 4:1. I like those odds.
Recommended Trade Setup:
-- Buy GDXJ at the market price
-- Set stop-loss at $25
-- Set initial price target at $34 for a potential 26% gain in six weeks
Note: Over the past year, one little-known indicator spotted 29 stocks right before they jumped double digits in a month. Now, it's tagged another stock as an immediate "buy." In fact, it's flashing the same kind of buy signal as a stock that rose 266% in a year. Get its name here, including all the details on this indicator.
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