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Gold Trading Strategy - What All Traders Need to Know
BY TIO Staff
|July 30, 2024Looking to create your own gold trading strategy? This article explores the key factors that influence gold prices, including the relationship with the US Dollar, interest rates, and crucial economic indicators. We will also cover some common ways of entering gold trades by providing you with a walk through of gold charts. Let’s start by covering the factors impacting the gold market.
Gold is a favourite asset for many traders due to its relatively high liquidity and sensitivity to geopolitical events, inflation, and US monetary policy. Often viewed as a safe-haven, its value tends to rise when stock markets decline. Gold therefore, has a valued place in portfolios adding diversification. However, the US Dollar, also considered a safe haven, can counteract gold's upward momentum. This creates both opportunities and challenges for traders.
Unlike income-generating assets, gold provides no yield, making it more suitable for trading than long-term investing. Investors tend to prioritise yield and often maintain positions in dividend-paying assets even during uncertain times. Consequently, gold's appeal might diminish when higher-yielding alternatives exist.
Factors Influencing Gold Trading Strategy
Several key factors influence gold's price. Primarily, the inverse relationship with the US Dollar impacts gold's value due to its dollar-denominated price. A strengthening dollar typically depresses gold prices, and vice versa.
Interest rates
Interest rates play a crucial role as they drive the US bond market and therefore impact the bond yield and the value of the dollar. Lower rates can boost gold's attractiveness by reducing the opportunity cost of holding it, while higher rates can dampen demand. When interest rates are higher the dollar tends to appreciate following carry trade inflows. Investors borrow in countries with lower interest rates and invest e.g. in the US bond market driving the bond prices higher and yields lower.
Economic Indicators
Economic indicators such as the Consumer Price Index (CPI) and Non-Farm Payrolls (NFP) wield significant influence over gold prices due to their direct impact on Federal Reserve monetary policy. As a primary measure of inflation, CPI data offers crucial insights into the economy's health. High inflation typically prompts central banks like the Fed to adopt a more hawkish stance, raising interest rates to cool down the economy. This tightening monetary policy tends to exert downward pressure on gold prices, as higher interest rates increase.
The Non-Farm Payrolls report provides a snapshot of the US labour market, a key factor considered by the Fed in its policy decisions. A strong NFP reading often indicates a robust economy, which can lead to expectations of the Federal Reserve hiking the rates. As explained above, rising interest rates can negatively impact gold prices. Conversely, a weak NFP report might signal economic slowdown, potentially prompting the Fed to adopt a more accommodative stance, which could benefit gold.
Safe-Haven Asset during the Times of Trouble
Gold has proven its worth as a safe-haven asset during times of economic upheaval and geopolitical instability.
- During the early stages of the 2008 financial crisis, which eventually saw the collapse of major financial institutions, gold’s demand grew substantially as investors sought refuge from the volatile market.
- Both COVID-19 pandemic, with its unprecedented economic disruptions and Hamas’ attack on Israel, sent gold prices rallying higher as investors sought to preserve wealth amid uncertainty.
- The ongoing geopolitical tensions, particularly the conflict in Ukraine, have also contributed to gold's appeal. Such events often escalate market volatility and increase investor anxiety. In such environments, gold's perceived stability and scarcity become even more attractive, driving up its price.
Trading Session and Their Characteristics
Market volatility for gold is notably influenced by trading sessions. The global nature of the gold market means it's affected by Asian, European, and US trading hours. The European and US sessions tend to be more volatile, with overlapping periods exhibiting heightened activity and price fluctuations. Therefore, a gold trading strategy optimised for volatile market conditions should be applied during the European and US sessions while the Asian session, with lower liquidity and lower volatility, could be more suitable for range trading.
Gold Trading Strategies
Three common gold trading strategies include reversal, momentum, and breakout trades.
- Reversal Trades: These involve identifying potential trend reversals through price action signals like candlestick patterns. Entry points are confirmed by reversal patterns (double tops/bottoms, head and shoulders). Effective risk management includes stop-loss orders below or above recent lows/highs, with exit strategies based on previous support and resistance levels.
- Momentum Trades: This strategy focuses on riding the wave of strong trends, identified using moving averages and momentum oscillators. Bounces from moving averages can act as entry signals. Stop-loss orders below support or above resistance levels protect against losses. Exit signals arise from divergences in momentum indicators or signs of a weakening trend.
- Breakout Trades: Traders target price breakthroughs of key support and resistance levels. High volume and strong price movement confirm breakouts. Stop-loss orders are placed just below or above the breakout level, with exit targets based on the breakout range.
Let’s take a closer look at these strategies.
Gold Trading Strategy: Reversal Trades
Break of support & Lower Reactionary High
Lower reactionary highs that follow a violation of a recent key support level indicate weakness and can lead to the market reversing lower. Let’s walk through the reversal process in the above gold CFD chart.
On Wednesday, 17 July 2024, the gold market rallied to a new all-time high (ATH) of 2,483. However, as soon as the New York trading session started, the market sold off heavily, eventually moving well below the latest reactionary low at 2,461. Buyers stepped in above the prior ATH of 2,450 and managed to push the gold price to 2,475 before sellers took control and forced the market lower, pushing it below the bullish trend channel low and the old ATH level (2,450).
Though the market was still inside an upward sloping trend channel when the latest reactionary low of 2,461 was violated and the subsequent lower reactionary high was created, it was a sign of weakness. This led to more traders exiting their long positions. Eventually, the balance of supply and demand shifted to favour the sellers, and traders piled in to short the market, creating supply that could overcome demand.
When the market broke below the trough of 2,451, which was created prior to the lower reactionary high at 2,475, gold was no longer in an uptrend but was forming lower highs and lower lows. In other words, the market had reversed the earlier bullish trend, and the reversal had taken place.
Once the market closed below the old ATH level (2,450), it was ready to sell off and plummeted by almost $49 by the New York open on Friday, 19 July. The fall in the price of gold was intensified by the US bond market selling off, sending yields and the greenback rallying higher.
Not all market reversals are as clear and rapid as the above gold market reversal, but it serves as an example of the factors traders focus on in their market analysis before entering a trade.
Gold Trading Strategy: Momentum Trades
Momentum Pull Back Trades
The gold market was trending higher on 17 May 2024. The trend was characterised by higher lows and higher highs and with the 50-period Simple Moving Average also trending upwards, providing a strong indication of bullish momentum. When the market pulls back to the SMA (50) at 2,371 during the overlap of the European and US sessions, buyers take the opportunity to enter the market, sending the price higher. This initial bounce encourages more traders to join, further bidding up the price.
This pattern repeats the next day in the Asian session. After a slight dip below the SMA (50), buying activity resumes, and the market rallies once again from the moving average. This consistent support at the SMA (50) indicates a robust bullish sentiment. As the pullback ends, demand absorbs supply, propelling the gold price higher by over $70.
Some traders use the momentum indicator as an additional confirmation before taking long positions. When the 10-period momentum indicator shows higher values, it signals increasing strength in the upward movement. The latter buy signal, indicated by the second blue arrow, occurs when both the SMA (50) and the momentum indicator point higher. This confluence of signals provides traders with greater confidence to enter the market, leading to a significant rally. By Monday morning European time, the gold price has surged by over $70.
This scenario shows how gold trading strategies can utilise technical indicators such as moving averages and momentum indicators to identify entry points in an uptrend. The repeated bounce off the SMA (50) and the confirmation from the momentum indicator suggest the market is bullish and the uptrend could be ready to continue. It is worth noting that the price of gold can trade through the moving average and not reverse as in the above example. To manage the risk traders should use stop loss orders and use this strategy only if their own research shows that it can be useful.
Gold Trading Strategies: Breakout Trades
Gold Breakout trade
On Thursday, 9th May 2024, during the European session, the gold market formed a higher reactionary low at 2,306. This formation indicated institutional demand for gold, suggesting that the market might soon break above the key resistance level at 2,332. Later that day, during the US session, gold rallied past the 2,332 level and closed above it.
The one-hour close above 2,332 further demonstrated strength, triggering buy stops set by traders who were previously short on gold. This created additional demand and helped breakout traders to drive the price significantly higher. The strong rally following the breakout reached a maximum potential gain of slightly over $45.
In breakout trades, swing traders might consider exiting long positions once the market begins to show signs of weakness, such as wide bearish price candles. The first such bearish candle, indicating potential weakness, appeared during the European session on Friday, 10th May, the day after the breakout trade entry signal. This bearish signal suggested a shift in market sentiment, prompting traders to secure their gains and exit the trade.
Breakout and Retest Trades
Using the same breakout as in the earlier example, let’s walk through a situation where the market re-tests the breakout level and then bounces higher providing an opportunity for traders focusing breakout and re-test trades.
After the market started to decline on Friday, 10th May, gold retraced back to the 2,332 breakout level on the following Monday, 13th May. This is where buying resumed during the US session, and the market consolidated for several hours above the 2,332 level, providing multiple opportunities to enter long positions. The next day, gold started rallying strongly in the European session, resulting in a substantial rise that took the market higher by almost $115 by the next Monday, 20th May 2024.
This retest of the breakout level, now acting as support, attracted buyers and led to a significant upward move. Similar patterns, where former resistance levels turn into support levels after being breached are common. However, it’s important to note that some breakout and retest trades fail, underscoring the inherent risk in trading. This strategy, like all others, necessitates rigorous risk management to navigate the market's uncertainties effectively.
Gold Trading Strategy and Risk management
Risk management in trading is a crucial aspect that can determine a trader's long-term success or failure. To safeguard capital and create a gold trading strategy with positive long-term expectancy, adhering to specific risk management strategies is essential.
Firstly, it is vital not to risk more than a fraction of one’s trading account on any single trade. A common recommendation is to never trade with funds the trader cannot lose and limit the risk to 0.5% to 2% of the trading account balance. Those new to trading should lean towards the lower end of this range due to their limited experience. Traders with a proven track record, demonstrating a long-term positive expectancy in their trading strategy, might consider risking a bit more.
An important aspect of risk management is the placement of stop-loss orders. Stops that are too close to the entry price are likely to get triggered by normal market fluctuations, resulting in unnecessary losses. Therefore, stops should be placed far enough from the entry price to ensure that the trade has a statistical edge, reducing the likelihood of being prematurely stopped out.
Maintaining constant risk per trade is another key principle. As the distance between the entry and stop-loss prices varies, traders often adjust the position size accordingly. This approach ensures that the trader is always risking the same percentage of your account, such as 1%, regardless of market conditions. By varying market exposure while keeping the risk constant, traders can manage their risk more effectively.
Effective risk management in a gold trading strategy involves limiting the risk per trade, adjusting position sizes based on stop-loss distances, and placing stop-loss orders strategically. These practices help manage exposure and protect your trading capital, enabling long-term success in the markets.
Conclusion
Gold trading demands a sophisticated grasp of market factors, including geopolitical events, interest rates, and economic indicators. Strategies like reversal, momentum, and breakout trades can help traders manage market volatility effectively. Crucially, risk management is key to long-term success, necessitating careful use of stop-loss orders and appropriate position sizing. To refine these strategies in a risk-free environment, visit our website and register for a demo account today. Remember, trading CFDs involves significant risk of loss, and it's essential to understand these risks fully before trading.
While research has been undertaken to compile the above content, it remains an informational and educational piece only. None of the content provided constitutes any form of investment advice.
TIO Markets UK Limited is a company registered in England and Wales under company number 06592025 and is authorised and regulated by the Financial Conduct Authority FRN: 488900
Risk warning: CFDs and Spreadbets are complex instruments and come with a high risk of losing money rapidly due to leverage. 76% of retail investor accounts lose money when trading CFDs and Spreadbets with this provider. You should consider whether you understand how CFDs and Spreadbets work and whether you can afford to take the high risk of losing your money
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