Ready For a Routing In the Ratio
I just finished up a guest post on the gold/silver ratio over at Martin Kronicle. You can view the article here. The gist of it is that the ratio has reached a level where it has made major reversals in the past. If history repeats, the downside potential over the next year or two is significant.
With a ratio of nearly 80:1, I am looking at the spread between 8,000 ounces of silver and 100 ounces of gold. A position in the futures market can be created by subtracting the difference between the value of one 100 oz. gold futures contract and a the value of the sum of one 5,000 oz. silver futures contract and three 1,000/oz. ‘mini’ silver futures contracts.
The June-July gold (100 oz.)/silver (x8,000/oz.) spread is trading less than $1,000 away from the August 26th contract high of -$688. This could potentially turn into a double top or, better yet, a Wash & Rinse sell signal. That’s where the spread clears the old high, only to fall back below it and indicate that a breakout attempt was a failure.
Furthermore, the spread has closed above the rising 50-day Moving Average every single day since early November. This constitutes as an uptrend. But a two-day close below the rising 50-day MA (currently around -$4,098) for the first time in over three months would potentially trigger a bearish trend change.
How Aggressive Traders Might Do This
If you were a gun-slinging, gasoline drinking, fly-by-the-seat-of-your-pants commodities trader, you could try to short the June-July gold (100 oz.)/silver (x8,000/oz.) spread somewhere up here and risk a four consecutive closes above ‘even money’.
The reason for the four consecutive days above even money is because the spread only stayed above ‘even money’ more than four days in a row just once during the financial crisis. Therefore, a one or two-day event could be a temporary blip.
Then you could double up once the spread makes a two-day close below the rising 50-day MA. After all, the initial position would be showing a profit and you’d be adding more once price confirms.
If You Are NOT Crazy…
On the other hand, what would a conservative, risk-managing, always solvent trader do?
Probably the exact same trade!
The only difference between the two traders is in the position-sizing. The gunslinger may bet the farm on this trade. The smart trader will put on a position size that only risks a small percentage of his capital. If the trade doesn’t work, the conservative trader gets nicked and the crazy trader gets beheaded. If/when the spread gives a new sell signal, the conservative trader can try again. Not the crazy trader, though. He’s blown out all of his capital.
Sometimes the only difference between a winning trader and a losing trader is the risk management strategy, not the entry/exit signals. Make it a priority to become an expert on risk management and position-sizing. That’s how you get rich. More importantly, that’s how you stay rich.
For tracking purposes, the blog will make a hypothetical trade by selling one 100 oz. June gold contract and simultaneously buying one 5,000 oz. July silver contract and three 1,000/oz. July ‘mini’ silver futures contracts at -$1,500 (premium silver). Initially, the spread will be liquidated on a four-consecutive day close above +$500 (premium gold).
Additionally, the blog will make a hypothetical trade by selling one 100 oz. June gold contract and simultaneously buying one 5,000 oz. July silver contract and three 1,000/oz. July ‘mini’ silver futures contracts if the spread closes below the rising 50-day MA. Initially, the spread will be liquidated on a two-consecutive day close above the August high of -$688.