7.1 Basic gold trading strategies

Buy-and-hold (long term) ^[1]

Recall that gold has proven to hold its value throughout the centuries. A comparison of gold against nine major currencies since 1971 shows that the precious metal made gains of 10.8% on average.  

Here’s how the precious metal fared against each individual currency: 

Given this dependable long-term performance, gold is well-suited to a buy-and-hold passive investing strategy. Note that sufficient time must be given for this strategy to work, as on occasion, gold has underperformed, falling against certain currencies. 

For instance, in 2021, gold fell 5.9% against the USD; 3.4% against the GPB; and 5.9% against the CAD, to name a few. All told, the commodity ended the year down by 2.4% on average against the nine mentioned currencies, marking one of three occasions that gold had ended in the red versus currencies since 2004.  

Position trading strategy 

Because gold is denominated in USD, the two share an inverse correlation. Hence, during times of high inflation (weaker purchasing power in the USD), demand for gold tends to go up (because more gold can be purchased when the USD is weaker). ^[2]

This has led gold to be widely known as a safe-haven asset – i.e., gold price goes up when  inflation surges. 

Thus, another basic gold trading strategy is position trading, where a trader could take a position in gold in anticipation of how prices will move in the near future. For instance, if inflation levels continue to climb, an investor might take a long position which creates the potential for payoff when gold demand rises higher in response.

News trading strategy 

Besides inflation figures, the price of gold is also impacted by several other economic and political news and developments. 

Examples include central bank gold buying activity, where sustained increases can drive price rallies; levels of worldwide demand from jewellery and industrial sectors; economic recession or market downturns; news of increase in gold production capacity; and even survey showing preference for gold (instead of silver or other precious metals) among current investors. 

Traders should pay attention to relevant news reports and watch out for potential trading ideas or upcoming opportunities. 

7.2 Risk management ^[3]

While gold has proven its worth over time and is widely regarded as a “safe-haven” asset, that does not mean gold trading is without risk. The commodity has its own cycles of volatility and may not always act as expected. 

For example, between 2021 and 2022, gold prices trended largely sideways even though the US was facing multi-decade-high inflation levels. ^[4]

Hence, it is important to practise proper risk management when trading gold. Keep the following tips in mind:

• Use stop-losses to limit risk. Learning how to set proper stop-loss points will help you reduce losses should the market go against you. 
  
• Set take-profits to stave off greed. If you open a long position on a gold trade, it is prudent to set a take-profit order to automatically close your position when the price reaches your chosen profit point. This helps to avoid the temptation of keeping a position longer than necessary, putting your gains at risk of market reversal.
  
• Choose appropriate position sizes. Do not risk too much of your capital in any one trade, as large losses are more difficult to come back from. Instead, limit your position sizes to between 1% to 5% of your account so you can be more resilient against losses, especially should several happen in a row. 
  
• Use leverage with caution. When trading gold on leverage, such as with gold CFDs, be sure to use ample caution. Use leverage only on safe trades, and even then, only when your account can withstand the increased loss should the trade go against you. 
  
• Compare with past trends. Some traders believe that “the market never repeats but often rhymes.” This saying points out that while the market is inherently unpredictable, there are patterns that can be discerned from past instances. Thus, one way to manage risk is to study past occurrences and compare them to current trends; this will help you understand if the market is behaving as expected, or if you’re experiencing an anomaly. 

7.3 Technical tools

There are several technical tools and indicators that can be used on a gold price chart to discern patterns and gain insight into the state of the gold markets. Different technical tools have different uses; for instance, some can be used to spot upcoming trends, while others can confirm (or deny) trading ideas. 

By combining several technical tools together, gold traders can obtain a more educated picture of where the gold markets may be headed next, and prepare suitable trading strategies in response.

It is crucial to understand that technical tools are merely that – tools – and cannot provide 100% accuracy or confirmation. No technical tool is infallible, and different technical indicators may produce varying readings. 

Relative Strength Index (RSI) ^[5]

The RSI is a momentum oscillator that is used to measure the speed and change of price movements in the gold market. This, in turn, can be taken as a barometer of market sentiment – upswings in the RSI can indicate market exuberance, whereas downswings in the RSI mean market sentiment is not strong enough to sustain an emerging price rally. 

The indicator oscillates between 0 and 100, and traditionally, readings of 30 and below indicate oversold territory and readings of 70 and above indicate overbought territory. 

Additionally, RSI can also be used to show bullish and bearish trends, with stronger trends shown by longer readings. Readings between 40 to 90 tend to indicate bullish trends, with the 40 to 50 zone acting as support. Meanwhile, bearish trends are usually shown by prolonged readings of between 10 to 60, with the 50 to 60 zone acting as resistance. 

Note that RSI can also chart patterns that are not indicated on the underlying price chart. Such divergence may indicate an upcoming trend reversal. 

Moving averages ^[6]

A moving average (MA) is a widely used technical indicator that creates a constantly updated average price of gold over a period of time. This blunts out the impact of fleeting or short-lived price spikes that show up in the price chart, in effect smoothing out the noise generated from market volatility. 

There are two types of moving averages. A Simple Moving Average (SMA) calculates the simple average of all gold prices in the past duration, giving equal weightage to all prices included. 

An Exponential Moving Average (EMA) is more heavily weighted towards the most recent few prices in the series. This makes the effects of recent price changes more pronounced.

Both SMA and EMA can be used flexibly, as you can assign any number of days to be measured. MAs can be used singly; in the case of gold the 50-day MA usually acts as a line of support and resistance. However, when used in pairs – one shorter duration, one longer duration – MAs can be used to indicate price trends. 

For example, you may chart a 10-day SMA and pair it with a 50-day SMA. When the 10-day SMA crosses over the 50-day SMA, this indicates a bearish trend may be forming. When the 10-day SMA crosses under the 50-day SMA, a bullish trend may be forming. 

One popular MA format is the Triple Exponential Moving Average (3EMA). This combines a 20-day, 50-day and 200-day EMA lines to spot emerging price trends, with the 3rd EMA line acting as confirmation.

Moving averages convergence divergence (MACD) ^[7]

MAs can also be used in a more advanced application in the form of MACD, which is another popular technical indicator used in gold trading. 

A lagging indicator, MACD charts the relationship between two EMAs of the price of gold to  identify price trends, measure trend momentum, and identify market entry points for buying or selling.

It is conventionally derived subtracting the 26-day EMA from a 12-day EMA, with the  difference forming the MACD line. A 9-day EMA of the MACD line is then plotted as the signal line, used to trigger buy or sell signals. 

In short, here’s how the MACD works in gold trading. When the MACD line crosses above the signal line, this is a buy signal and traders may take a long position on gold. When the MACD crosses below the signal line, this indicates a sell signal, and traders may go short on gold instead. 

Time’s up

Module recap

• A variety of trading strategies can be applied to gold trading, and even basic ones can work well. Some of these include buy-and-hold, position trading, and news trading.
  
• The buy-and-hold strategy is viable especially over a long term. This is evident given gold’s strong performance against the world’s top currencies. Since 1971, gold has gained 10.8% on average against nine leading world currencies.
  
• Position trading strategy for gold entails taking a position early when economic indicators point to an emerging price trend. 
  
• Similarly, news trading in gold relies on keeping track of relevant news and developments to spot upcoming trading opportunities. Some of these include central bank buying activity, consumer trends, economic recession or downturns, and gold production levels.
  
• While gold may have a reputation for being a safe-haven asset, market volatility and risk is still present. As such, proper risk management must be instilled when trading gold.
  
• The use of technical tools and indicators can provide traders with a more in-depth view of the gold market. Some popular technical tools are Relative Strength Index (RSI), Moving averages, and Moving Averages Convergence/Divergence (MACD) 

References:

1. “Annual Performance Of Gold – IGWT Report”.  https://ingoldwetrust.report/chart-performance-table-gold-silver/?lang=en.
2. “What Drives The Price of Gold? – Investopedia”. https://www.investopedia.com/financial-edge/0311/what-drives-the-price-of-gold.aspx. 
3. “Risk Management Techniques For Active Traders –  Investopedia”. https://www.investopedia.com/articles/trading/09/risk-management.asp.
4. “Is Gold An Inflation Hedge? – Forbes”. https://www.forbes.com/advisor/investing/gold-inflation-hedge/.
5. “Relative Strength Index (RSI) – Fidelity”. https://www.fidelity.com/learning-center/trading-investing/technical-analysis/technical-indicator-guide/RSI.
6. “Moving Average (MA): Purpose, Uses, Formula, and Examples – Investopedia”. https://www.investopedia.com/terms/m/movingaverage.asp.
7. “What Is MACD? –  Investopedia”.  https://www.investopedia.com/terms/m/macd.asp.