Trading Above the Clouds

By Scott Silva

Editor,  The Gold Speculator

2-14-12

Technical analysis is replete with analytic tools, techniques and systems all designed to provide insight into the future price movement for a traded security. The technician relies on price and volume history to predict future outcomes. Can looking at the past be a reliable guide to divining the future? Can anyone drive a car by looking only at the review mirror? Amazingly, in trading securities, the answer is yes.

This is because the markets for stocks, bonds, commodities and virtually any traded good is driven by human behavior. In the search for profit, buyers and sellers act in their own self interest. The buyer always buys at a discount to his perception of the security’s value. Likewise, the seller always sells when he perceives value is realized, or his capital is better used elsewhere. When a transaction occurs, the buyer and the seller each believe they have struck a bargain at the mutually agreed sum. As Adam Smith instructs us, this is the magic of price in a free market.

So how does price history guide the investor? Well, it turns out that price movements develop distinctive patterns of human behavior in the markets. When a stock or commodity is considered undervalued, the buyers step in, bidding the price up. Likewise, when prospects for the commodity diminish, then sellers rule. It the dynamic pressure between sellers and buyers over time that creates the peaks and valleys we see depicted in the charts. Price history creates repeatable patterns. Understanding chart patterns is the key to predicting future price action.

You have seen in these pages before, I believe one of the best analytic tools for predicting future commodity prices is Ichimoku Kinko Hyo. It provides “equilibrium at a glance”- all we need to know about the state of the traded good as well as its likely future price. Let’s examine gold using Ichimoku Kinko Hyo, to see if we should buy sell or hold gold today.

Here is the Ichimoku chart for spot gold. Most trading platforms and chart services include this indicator set. I use the Thinkorswim trading platform from TD Ameritrade. It provides excellent technical analysis tools and Level II access to stock, option and commodity futures markets in a single, integrated platform.

We can see immediately that gold is in a bullish trend on the daily basis. The Ichimoku Kinko Hyo chart feature that signals the bullish state is price action above the cloud (“moku” in Japanese) represented by the pink and green shaded areas. (Conversely, if price action were below the cloud, the trend would be bearish). The cloud represents support and resistance levels. It is constructed by traces of two leading lines, known as the Senkou Span A, and the Senkou Span B. Together they form the complete view of longer-term support and resistance. One of the kumo's most unique aspects is its ability to provide a more reliable view of support and resistance than that provided by other charting systems. Rather than providing a single level for support and resistance, the kumo expands and contracts with historical price action to give a multi-dimensional view. Also, the kumo projects support and resistance levels into the future.  We can see the cloud is projected into the future, and that in early March, the cloud changes color form pink to green. This reversal is a bullish indicator. Without the cloud predicted cloud reversal, we would not make a long trade today. The projected cloud tells us that resistance level changes to 1710.89 (top of the projected green moku) and support is 1645.50.

The next set of Ichimoku indicators important to our trading decision is the relation of the Tenkan Sen (blue line) to the Kijun Sen (red line). These are trend lines, similar to short-term and longer-term moving averages. A strong buy signal occurs when the Tenkan Sen crosses above the Kijun Sen from below. A strong sell signal occurs when the Tenkan Sen crosses from above. We can see the Tenkan Sen made a bullish cross on January 17^th when gold opened at 1635.80. Together with the price action/kumo bullish indicator, the bullish projected kumo indicator, the bullish cross by the Tenkan Sen remains intact, so we are not prohibited from taking a long position as yet. We are close to deciding, however.

The last an perhaps the most important Ichimoku indicator we need to check is the Chikou Span (green line) in relation to price action and the kumo. The Chikou Span is current price projected back 26 periods. The Chikou Span gauges the strength of the current trend. The bullish trend is strong when the Chikou Span is above price action and above the cloud. The bearish trend is strong when the Chikou Span is below price action and below the cloud. The trend is neutral or week when the Chikou Span touches prices action or is in the cloud. We can see that the Chikou Span is above price action and above the cloud for gold, another bullish signal.

Together, the five Ichimoku indicators show gold to be in a bullish trend. Ichimoku trading rules all indicate it’s safe to enter a long position in gold today, or to hold a long position in a portfolio.

The Ichimoku indicators tell me it’s safe to buy silver at today’s prices as well.

Trading precious metals above the clouds using Ichimoku indicators is an excellent way to increase the value of your portfolio.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

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