By Ryan McGuire
Gold Avalanche
www.goldavalanche.blogspot.com
Ok before we get into it, a few disclaimers.
1) You may not copy this article without my expressed consent. Any original work copied from this website must be referenced accordingly.
2) This is not personal investment advice, and should not be construed as personal investment advice. I am not an "expert", nor qualified to give you investment advice. This is just me telling you some things I've discovered about some really common tools of the trade. The result is a strategy which I have adopted and I invite you to explore. This strategy is best used on companies which you already have researched and done your own due diligence on. We can also use this methology on commodities futures prices, as it can give an excellent gauge of market sentiment with a reasonable, yet not overwhelming effort.
So ... as promised, here is a recommendation along with some important information on how to find reasonable risk-adjusted long-term buy levels for stocks, mutual funds etc which have gone on sale.
Our recommendation is the Market Vector's Gold Miners ETF (NYSE:GDX). This ETF is great for US investors who want exposure to large cap gold producers, but who don't have the time to sift through the financial details of every company.
Below is the chart that will help us find a buying time frame. Please note that this strategy will not give us a specific price, only the best time to buy and a potential price target range. So, patience and weekly monitoring of the chart is vital to the success of this strategy, as well as the use of limit, or stop-limit orders so that you stay in total control of exactly when and at what price you buy. Avoid market orders like the plague, as they give over control to someone else, who is looking out for their best interests .. not yours!
First, notice that we are primarily using the weekly chart, and that we are taking a long time view of the stock. Taking a long view is important because it helps us see how things have worked out in the past, and gives us a sense of sentiment over time. Using the weekly charts in combination with the daily charts is important for gaining context into the price movements of a stock. Weekly charts help to remove a lot of the noise of the daily swings, but it is good to double check your assumptions garnished from the weekly charts on the daily charts.
IF no clear signs are being given on the weekly charts, we can use the daily charts to zero in on possible indicators. This can also help us reduce risk by ensuring that we don't accidentally miss an opportunity, or buy on a botched assumption of "the bottom being in". Another reason to use the weekly charts is that when a stock sells off at the beginning of the week, it will often give back at least some of the losses over the course of a few days, which could translate into a stock retaining some temporary strength in the midst of a broader downturn. We need to be mindful of this lest we accidentally buy high when we think we are buying low.
Detail 1: When price, RSI, and Wm%R coincide on the downside on both the weekly charts and the daily charts, this sends us a strong and reasonably reliable signal that the stock is oversold as well as cheap in real terms. Nothing is perfect, but this indicator, along with a strategy of buying in tranches is surprisingly good.
Detail 2: Sometimes, one of the signals won't mesh completely with the others. For example, in our chart above, the RSI didn't quite breach the 30 level on May 14th, 2012 when the other indicators were screaming "BUY ME!". As a side note: an RSI reading of above 40 indicates positive momentum, while an RSI reading below 30 indicates that the stock is oversold. Because of this reading, we can conclude that even though the other two signals were flashing "buy" signals, there is a chance more pain is ahead for the stock, so we should check the daily charts before deciding what to do.
Detail 3: Other times, and specifically with the RSI, you will see the RSI's trend start to improve (see the picture below) while the Wm%5 remains oversold. If the stock's price bottoms out during this time when RSI is improving and the Wm%5 shows 'oversold', this creates a confident buy signal.
On the GDX above, you'll notice that all three of our indicators almost lined up on the weekly charts. RSI was right on 30, Wm%5 was showing oversold, and the stock's price was extremely depressed. Not good enough. All three conditions MUST be met on both the weekly charts and the daily charts for a buy signal confirmation, OR RSI needs to be improving while the other indicators lag.
Here it is in a nutshell
Weak Share price + Wm%5 oversold + RSI below 30 on weekly and daily charts = Buy 1 tranche
Weak Share price + Wm%5 oversold + RSI trending from below 30 to above 30 = Confident Buy
Weak Share price + Wm%5 oversold + RSI above 30 = DO NOT BUY
So what's the current situation with GDX? Well, on the week ending May 14 2012, GDX put in a 52-week low of $41.62. At that time, Wm%5 was showing oversold, and the RSI hit 30. Then, on the week ending July 20th, 2012, GDX finished at $41.75, just barely indicating an upward trend in price. The RSI has not reached oversold levels again, but is also not above 40. However, the RSI is at least showing improving internal strength despite the oversold level of the Wm%5.
We had better look to the daily charts, just in case the weekly charts have missed something.
The daily charts are showing that a bottom was made on May 16th, with both the RSI, Wm%5 and the share price confirming each other. Since then, the trend has been up ... slightly. So, we can conclude that even though the weekly charts did not give us all of the confirmation we were looking for, the daily charts filled in that gap since the bottom came the Monday after. We can thus conclude that if you have a risk appetite, now is a great time to buy a stake in GDX, but not a full stake. Just ONE tranche. We recommend breaking your capital up into two or three chunks for deployment. If a confident buy signal is made, feel free to either buy a second tranche, or simply deploy the rest of your capital and wait for the good times to roll.
One note of caution: it is INSANELY important to use the weekly charts as your benchmark, and the daily charts for confirmation. Many times, the daily charts will give a false signal during a stock price's decline, but when the signal meshes with the weekly signals, the chances are extremely good that a bottom has been made.
One of the best tactics you can use to manage the risk of this trade (or any trade) is to buy tranches when these signals are given. Although a bottoming stock price combined with a rising RSI and an oversold Wm%5 is almost universally a sign to back up the truck, you won't always be so fortunate as to see this signal being given, or you may misinterpret the signal. So when you do see it, MAKE SURE you have it right, and make sure you are investing in a quality company - and then buy!
Peace,
Ryan
