Daily GLD Chart Update - How To Read This Chart

This post was originally penned yesterday, but given a few conflicting client meetings, we were unable to post it.  The markets are acting a bit out of turn today with stocks lower, dollar lower, and gold up.  See our post (keep in mind most of it was written yesterday) below to get a better sense of where we believe things are going.  We'll update briefly this evening with the latest to see if we're on track.

The original post:

Though the USDX was down today, gold was unable to break above 1400. As we mentioned previously, we believed that the dollar would run out of steam and turn lower, but gold would not react and would move down. To understand that position a bit better, take a look at this chart.

Again, here we use the GLD ETF chart because it's quick to analyze on a day-to-day basis.  There's a lot going on in this chart, and we hope to step you though it in a way that makes sense.  We recommend opening the chart larger in another tab in your browser for easier viewing.

Note that prices are on the left and dates are along the bottom.  The blue candlesticks are up days (traditionally clear or "white" candles) and red candles are down days for GLD, and by proxy, the spot gold price.  The upper right hand corner shows some important stats: the day's open, high, low, and close (in parentheses), the low and high values for the time period being measured (108.8208 and 139.15, respectively), the mechanical model for what market phase we're in (in this case, a bullish uptrend with an averaged trendline at 8.5 degrees above the horizontal), and finally the period of time being measured, including the number of candles (bars) on the chart.

The upper left hand corner shows what moving averages are on the chart.  First, the very important 150 day simple moving average in red, the 4 day weighted moving average in orange, and the instantaneous trendline in dark green (more about that below)

The bottom section is the Hilbert Transform sine wave. There are two lines, one red (the sine wave) and one black (the lead sine wave).  At any give time, the values of these waves oscillates between 1 (at the high end of the indicator) and -1 (at the lower end of the indicator), with the 0 line being shown as the horizontal dotted line in between.  Under the title at the top center are the values of the sine and lead sine for the day.

Before we discuss the other indicators on the chart, it's time for a little theory.  Mathematically speaking, we can define the price movement over time of any security as a combination of a cycle and a trend.  That is, the price moves up and down in a cycle that is reasonably predictable and statistically measurable.  However, sometimes prices just take off up or down for long periods in a trend.  Traders tend to look for trending movements and indicators that point to a trend likely developing.  This is because the big money is made by getting into a trend and riding it out.  Markets that "move sideways" are often very choppy.  Traders tend to lose money in these markets because it is difficult to call the tops and bottoms of moves.  The general momentum trading strategy is to get into a trend early and ride it until it fades, then find another trend and jump on board.

The Hilbert Transform is a way of determining when something is trending or cycling.  When cycling, we have found the Hilbert Transform to be very, very good at picking tops and bottoms.  When trending, it is best to use other indicators and use the Hilbert Transform as a secondary indicator.

With that said, this chart shows you how to determine what's occurring with the price of a security in terms of cycles or trends (it's something we've developed internally to show this specific format).  When trending, ride the trend.  When cycling, sell when the cycle turns.

Looking at the sine and lead sine waves at the bottom, the key is to follow the red line (sine wave).  When the sine wave peaks, a turn to the downside is likely as long as the security is in a cycling mode.  If the security is in a trending mode, then any pullback is likely to be minor and not worth selling.  The black line (lead sine) is mathematically computed as a predictor for what's about to occur with the sine wave.  As the name implies, the lead sine wave leads the sine wave just slightly, so when it turns back down and crosses the sine wave, you know that a cycle turn is imminent.  When this cross occurs, two visual indicators are placed on the chart.  The first is a red (resistive) or green (supportive) circled "H" with a white interior and a gray vertical dotted line.  This means that a cyclical turn is ABOUT to occur (in 1/16 of a cycle, or typically 1-2 days).  Note that we have such a red circled "H" with white interior today.  Once the sine has topped (or bottomed), a red (resistive) or green (supportive) horizontal dotted line is drawn at the approximate resistive or supportive level as a reference.

We should take the cycle tops and bottoms as warnings of a possible turn.  If the underlying security is behaving cyclically, many times the turn will be exact or off by 1-2 days at most (we look at fractals and other signs for confirmation).  Often, however, we will see some "overshoot" of the high (or low) point that lasts for a few days.  As long as the security is not trending, the price tends to "hang around" the red or green line.  These lines should be viewed as "price magnets."  It is common that if the price overshoots, it will not overshoot longer than 1/4 of the cycle.  If the price overshoots resistance, at 1/4 of the cycle we will get a green triangle indicator.  If the price overshoots support, at 1/4 of the cycle we will get a red diamond indicator.  These will also often mark points when we get turns during an overshoot whenever the security is cycling.

For securities like gold, which is in a very strong bull market, the security tends to trend more than cycle.  Cycling tends to occur after a major trending move when you get a strong pullback in price--then you get a period of base building, characterized by a range-bound trade of ups and downs.  That period is a cycling period.  When the price breaks up or down outside of that range, it is more-often-than-not the beginning of a trending move.  The instantaneous trendline (dark green) is a mathematically computed line that attempts to remove the cycling component from the trend.  Said another way, the instantaneous trendline shows the price trend at any given instant without the cycle tendency being included.  When a trend begins, price will often ignore the cycle tops and bottoms and start moving consistently above or below the instantaneous trendline.  The beginning of a mathematically computable trend is marked with a red (downward) or green (upward) circled "H" (note that it is a solid color, not "hollow" like the cycle indicator)and a vertical, solid blue line.  At the end of a trend, a cycle period is likely to take over.

While that's a lot of data, it is easier to see on the chart. From the 4/1/2010 date, we can see the gold price staying above the instantaneous trendline in a trending pattern (bouncing off of the instantaneous trendline frequently).  On 7/1/2010, the price fell and ended the upward trend (shown with a solid red circled "H" and a blue vertical line). On 7/9/2010, the cycle indicator showed a potential turn to the upside (which we held out for waiting for a bottom at the 150 dma).  On 8/4/2010 the gold price began to trend upward again after having bottomed for one cycle (frankly, we expected it to cycle longer than that, but...).  The price has continued to trend upward to today, with a possible warning that states tomorrow may be a short term gold top.

If you had been following this chart, you would have bought on 2/17/2010 (not shown on the above chart) at the beginning of the trend at roughly $1100 per ounce, sold on 7/1/2010 at $1200 per ounce (9% profit), bought back at $1155 per ounce and you'd still be holding today with a potential signal to sell around $1400 (21% profit or 30% profit total since February).  It's not clear whether or not the top will be reached on December 3, but the current situation presents itself as a possible top.  If so, selling near Friday's highs (at least lightening up) may be advisable.  A price drop below 1360 for a day or two implies the trending move will be over and a period of consolidation will be in order.

You can see that, in bull markets, the trend is to have short positive cycles and long trends during negative cycles.  The reverse is true for bear markets.

Note that cycles occur in all timeframes--daily, weekly, monthly, etc.  At any given time, one cycle may be the dominant cycle that must be paid attention to.  Currently, the weekly and monthly cycles are negative, but trending.  The weekly cycle has only stopped trending once in the last 10 years and that was during the credit crisis of 2008.

Note also that we also use fractals to determine the likely day (week and month as well) of the top or bottom.  When combined with other indicators, especially the Hilbert Transform, turns become much more predictable than with traditional indicators alone.  Gold currently has some signs of a possible downturn on both the daily and weekly charts.  Only a sustained move above the former highs will negate that possibility.

At this stage, we believe we're overdue for a gold pullback.  Let's see we see a top on Friday.