News Flash March 2001: Gold is Outperforming the Dollar

No the year was not a typo, Gold has been outperforming the dollar for 10 years now. That is a long run. Focusing on price action in the charts is in a sense dwelling on the past, but the patterns that emerge can help prepare for what might happen in the future. So lets study this 10 year run for a moment in the chart below.

The trend from the lower left to the upper right on this chart of the weekly ratio of Gold/US Dollar Index is clear, but there have been a few pullbacks along the way. The red hats show that each time there has been a pullback the Relative Strength Index (RSI) was near 80, overbought. Next, the Moving Average Convergence Divergence (MACD) has crossed down when these pullbacks have occurred. Third, in all pullbacks expect for the one related to the recent Financial Crisis, the 50 week Simple Moving Average (SMA) of the ratio has been support. Fourth, the pullbacks all occurred when the ratio had broken through the top of the Bollinger bands. Finally the current position shows it well above the 50 week SMA, but with a MACD that is crossing bullish and and RSI under 70.

What to do with this information?

Below is a close up of the ratio on a weekly basis for the last 4 years. I have replaced Gold and the US Dollar Index with their ETF proxies SPDR Gold Trust Shares (ticker:$GLD) and the PowerShares DB US Dollar Index Bullish Fund (ticker: $UUP).

Notice that this close up shows the recent channel and then as the Bollinger bands squeezed a breakout of the channel to the upside with Bollinger band expansion. Three key levels to note from this chart. The current ratio is at 6.37, the 50 week SMA at 5.45, and the RSI is at 66.25. Using these three levels we can create a simple trading system.

System Rules

There are just a couple of rules required for this system using the weekly ratio chart.

1. Be long the ratio after a move above the 50 week SMA until the RSI reaches 80 or has at least gone over 70 and then starts to fall.
2. Then be short the ratio from when it falls below the 70 RSI until it touches the 50 week SMA and starts to rise or rises without touching it.
3. Use a 2% stop to protect against false moves.

The chart is also labeled with buy, sell and short sell signals with pink lines indicating the move from an opening to a closing transaction. Notice it wold have generated 10 trades over the last 3 years, 8 of then long and only 2 short sales. The last buy signal is left open. Now I am sure that someone can rev this system up and get some more juice out of it. But the point is to keep it simple and be prepared for the next opportunity. So the next trade will either be a stop out or a close out and reversal if it exceeds a 70 RSI. With the ratio at 6.34 you would sell 700 GLD and buy 4500 UUP if the reversal and short sale signal is given. This would make it dollar neutral. This is not a perfect system but the point is if you are not thinking like this then it is time to start. Play around with it and make it your own and then trade’m well.

(As always you can see details of individual charts and more on my StockTwits feed and on chartly.)

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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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