‘Follow the trend’.
Millions of traders preach these wise words around the world, every day.
It’s nothing new…
The goal is to buy stocks when they are going up, and ride them for as long as possible.
Sounds easy, doesn’t it?
Well, maybe not. If it were easy, most traders would be millionaires and my skills wouldn’t be needed today. For this reason, let’s talk about momentum trading and gold.
There are two options.
You can sell at a desired profit, say a 20% targeted gain, which takes discipline. Or, you could hang on for the ride and try to sell near the top.
Most punters normally go for the second option, wanting to reap the big rewards. In doing so, another question pops up: how will you know when your shares peak?
To put it simply, you can’t know.
Moreover, if your shares peak and then pull back, it might not last. The share price could surge onto new highs in the months ahead. It’s happened countless times to countless stocks. For example, check out Commonwealth Bank [ASX:CBA] on the chart below: (Please note that this is an example. I believe we’re facing another financial crisis and don’t advise buying bank stocks today).
Click to enlarge
Looking at the chart, if you sold your shares during the pull back to $75 per share in early 2014, you would have missed the massive rally to $96.17. Likewise, if you sold your shares during the middle of last year’s correction, you may have missed the $15 rally to $85 per share. Of course, if you bought near the high — thinking that the trend would continue — it would have been a poor decision to hang onto your shares.
While many people argue you should ‘follow the trend’, momentum trading isn’t easy. The trend can change very quickly, putting you on the wrong side of the trade.
Without a stop loss, which most investors don’t use, the decision to sell can be difficult. If you sell during a pullback, you could miss out on big profits in the future. For this reason, most punters tend to hang on for the roller coaster ride.
When the times are good and lots of people are making ‘easy’ money — like in gold stocks today — more investors will pile onto the bullish bandwagon. Unfortunately, this lack of common sense is why the majority tend to buy near the high.
This poses an issue…
Once you become an investor, and the share price drops by (say) 30%, what should you do?
There are two options. If you hold a profit, you could sell and lock in those gains. I mentioned before that this is unlikely, especially with the potential of a short-lived pullback. Alternatively, you can buy more shares for the long term, which is what most people tend to do.
Looking at the big picture, most long term investors believe that pullbacks are buying opportunities. Investors who bought near the top try to average down. Investors who remain profitable tend to ‘top up’ — it made them a lot of money in the past, after all.
Of course, it could be the wrong decision to buy…
Imagine if the share price nosedives and starts trading 50–70% below the high. What should you do?
A few lucky investors who bought low could still be in profit. They will most likely hang on for the ride.
Most investors will probably stick with the stock, wondering why they didn’t sell near the high when they had the chance. Perhaps, if the share price starts to rise, they might buy more again on the way up…
On the flipside, if the share price doesn’t bounce back, investors may keep the stock for the ‘long term’. Although, the longer the recovery takes to transpire, and the more the share price falls, the more frustrated the shareholder is likely to become. When this happens, investors tend to sell. This tends to happen near the low.
If you look at the story, the majority buys near the top, and — when the going gets tough — sell near the bottom. The warning is loud and clear.
I expect this story to repeat with gold stocks in the months ahead.
Fortunately, earlier this month, an extremely poor US jobs report changed everything. After watching the gold price plummet, it bounced back quickly. Last week, gold hit a new high of US$1,315.48 per ounce. Gold stocks have largely recovered across the board. The Vaneck Gold Miners Index [ASX:ASK:GDX] hit a high of $36.33 per share last week, which is more than 100% higher than the January low of $17.99.
Mainstream analysts and multiple billionaire investors are telling you to buy gold stocks, and that the bull market has started. I believe this is a very wrong and dangerous call. It should see the majority buy near the high. To understand why, check out this monthly chart on gold.
Source: Tradingview.com, Resource Speculator
Click to enlarge
The chart above shows the big picture view gold. There are three important trend lines on the chart. The green trend line shows the main support, dating back to 2002. This trend lines up with my target of US$931 per ounce, which I expect to get hit in the months ahead.
The pink trend line shows support dating back to the 2011 low. This trend lines up with the 2013 and 2015 lows, which gold bounced off both times. I expect this trend line to break in the months ahead, as we move into the major low.
The blue trend line is the most important. It shows the 2011 high and the 2012 retest, which now form resistance at US$1,385 per ounce.
I’ll make it crystal clear: gold must close above US$1,385 per ounce on a monthly basis to warrant any excitement. Indeed, gold could retest US$1,385 per ounce this month and then swing back down towards — at least — US$931 per ounce. This could happen very quickly.
Adding it up, I could not care less if gold hits US$1,385 per ounce this month. I am looking at the big picture story. While it remains in a long term bull market (i.e. 17 years up from the 1999 low), gold is in a short term bear market (i.e. nearly five years down from 2011 high). The recent rapid rise in gold means nothing. For multiple fundamental and technical reasons, I remain extremely bearish on gold in the short term.
At the end of the day, Resource Speculator is an investment advisory service, not a momentum trading service. If you made 100% or more during this gold rally, that’s great. But, it pales in comparison to what you could make in the future. When the time is right, I’ll recommend the best gold stocks to Resource Speculator readers.
If you want to know more on this story, click here.
Resources Analyst, Money Morning