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Best gold trading strategies

Gold holds a unique place in financial markets and understanding how to trade the metal and what drives the price is useful for all investors.

Gold trading

Gold has long been regarded as a ‘safe haven’ in times of uncertainty, providing refuge to investors when foreign exchange, equity and other financial markets are unsteady, and has earned a distinctive role in the world of finance.

Although technically a commodity much like oil or copper, the gold price is not materially affected by the level of industrial supply and demand and instead plays an outsized role in financial markets. The vast majority of the world’s gold is held for investment purposes, with only 10% thought to be used for its physical characteristics within industry. And, while not underpinned by a single economy, gold also shares features with forex in the way it is traded around the globe in a uniform manner, but differs because its physical form is deemed to give it intrinsic value.

There are numerous ways to trade gold: futures and options allow investors to take positions on the future direction of the price, while mining stocks and gold exchange traded funds (ETFs) provide the opportunity to trade gold in the same way you do a stock.

We have a look at how to trade gold and the nine things you need to know when forming your own gold trading strategies using a blend of fundamental, technical and sentimental analysis.

1. Understand the relationship between gold and foreign exchange

Gold plays a vital role within forex, both of which are traded 24 hours a day. The metal has a host of traits that has made it attractive for monetary purposes rather than as an industrious metal. It is scarce (the world’s gold would only fill around three Olympic sized swimming pools), divisible, portable and easily verifiable. But most importantly it is fungible: one unit of gold is no different to another and worth the same amount, making it tradeable.

Learn more about forex trading and how it works

The first thing to be aware of is that gold is almost always traded in US dollars, standardising the market around the world. This means what the dollar is doing is always relevant to gold traders. Although not a guaranteed rule the relationship between the gold price and the dollar acts in the same way as any other currency pair: when one goes up the other goes down, and vice versa. However, while currencies are directly influenced by government and monetary policy as well as changes in economic conditions at a national level, gold is not sovereign to any nation and the dollar’s movements are just one driver of its price.

The ‘safe haven’ appeal of gold comes down to the durability it has over currencies, which in extreme circumstances can become worthless if inflation soars too high: Venezuela and Zimbabwe are just two examples of countries that have seen their currency collapse in recent years. Gold on the other hand, is considered to hold a certain worth due to its physical form and acts as a store of value and as a hedge against inflation. This means investors flock to gold and other safe havens when appetite for risk dissipates and bullish mentality in the market waivers. If traders are concerned that there is too much risk in the forex market then the general strategy is to shift your money out of forex and into gold in the knowledge that exposure to volatility has been minimised until the forex market becomes attractive once again. Then generally, investors sell gold when positive trends emerge in forex, stock and other higher-risk markets and risk appetite increases.

Read more about how to predict forex movements

This is demonstrated by the financial crash of 2008. The highs of gold recorded in 2011 were spurred on by the crash of currencies and other markets a few years earlier, spooking investors who looked for a safe investment at a time of crisis, before falling back down as they began to regain some of their confidence and reinvest in other financial markets.

2. Gold trading strategies using fundamental analysis

With gold acting as an asylum for investors in uncertain times the mood of the market is a significant driver of price. Generally, if the market is feeling positive and optimistic about the outlook then this is referred to as bull market, and a pessimistic market that expects prices to fall is referred to as a bear market. With gold often being used for its ability to store value and minimise volatility the price tends to perform better during bear markets (which in turn creates a bullish stance on gold).

You can find out more on market sentiment and how to trade it in this article.

The gold price is driven by many fundamental factors, some of the most important of which we go through below:

3. Understand the relationship between gold, inflation and interest rates

Much of the fundamental side of analysing the gold market is based around central banks and monetary policy. Because gold acts as a hedge against inflation any announcements regarding quantitative easing (QE), regarded as a form of printing money, will often influence the price. Remembering that gold is mostly priced in dollars there is a direct correlation between gold prices and the US consumer price index (CPI).

Interest rates also play their role. Although there is not as direct a correlation between gold prices and interest rates the general outcome sees that higher rates make gold less attractive to investors. This is because higher rates offer better returns to investors putting money into savings accounts or other similar options, taking money out of the gold market. However, it is not uncommon for gold and interest rates to move in the same direction.

Read more about how to trade interest rates

Here, it is important to introduce real interest rates: the interest rate minus inflation. This is handy because it incorporates both drivers into one measure. One way of monitoring real interest rates in the US for example is examining the yield on Treasury Inflation-Protected Securities (TIPS), a treasury security that is indexed to inflation to help protect investors from suffering negative returns caused by it.

4. Understand the relationship between gold and geopolitics

Much like when investors are wary over the forex or stock markets, the price of gold often benefits at times of geopolitical uncertainty.

The $1920 peak price for an ounce of gold in 2011 was not only in the wake of the financial crisis but coincided with heightened tensions within the international community, with the Arab Spring revolutions in the Middle East and the tumult in Greece as a result of austerity measures introduced by the European Union (EU) after the country’s economic collapse. More recently, gold was a favoured option for investors when tensions between the US and nuclear-bearing North Korea began to ramp-up, before subsiding into diplomatic talks.

5. Gold trading strategies using technical analysis

Technical analysis for gold is no different to that of any other market and uses the historic price graph to identify past patterns that point to future trends. The key way to ensure the accuracy of any technical analysis conducted on the gold price is to confirm your findings by carrying out the same analysis of other gold-related securities, such as mining stocks or gold ETFs, which often move in line with the price of gold. A match across multiple analyses can give investors confidence behind any uptrends or downtrends that have been identified.

The most basic level of technical analysis demands investors identify previous highs and lows as well as any obvious trendlines or chart patterns.

Read more about technical analysis

Below we go through some of the technical analysis tools that investors can use to examine the gold price and other gold-related securities:

6. Gold trading strategies: moving averages

For traders with a short-term perspective, one of the most widely used methods of examining the gold price is using moving averages and a crossover strategy. This involves identifying the average movements in the price over a short and long period of time and treating the two passing one another as a signal to buy or sell. Moving averages are explained in more detail below:

  • Moving averages: the moving average aims to smooth out historic price data, calculating the average price over a certain period of time. For example, the 20-day moving average is the average rate over 20 days, and is recalculated each day. On day 21, the first day is dropped from the calculation. This allows traders to look how the current rate compares to the average, which will filter out any sudden or unexplained movements that could distort the historic price data.
  • Moving average convergence divergence (MACD): this takes the moving average over a short timeframe and an average over a longer timeframe. Traders look for when the short-term moving average crosses over with the long-term average. If the short-term moving average surpasses the longer-term average then it generally suggests that prices are heading higher.

Learn more about moving average trading strategies

Gold mining stocks vs gold chart

7. Gold trading strategies: pivot points

Pivot points help isolate the price at which sentiment in market is likely to change. Calculating the pivot point is done by simply averaging out the high, low and closing price of any given security. Although gold is constantly traded many will still coincide closing prices with when their preferred stock market closes. This pivot point is then used the following day to signal what mood the market is in. If the price of gold is rising above the calculated pivot point from the previous day then it suggests a bullish attitude, and higher prices in play while there is a drop below the pivot point implies the opposite.

Pivot points are often used as part of wider analysis of where the support and resistance levels are. If the calculated pivot point is lower than the spot price of gold then it is deemed supportive for gold prices while one below the spot price acts as the level of resistance.

Read more about support and resistance

There are numerous tools used to help calculate pivot points in the market, including:

  • Fibonacci retracement: this tool helps identify when to enter and exit trades using the ‘golden ratio’, which help find areas of support and resistance in the gold price. This is calculated by six levels that will result in significant price moves: the highest point (100%), lowest point (0%), the midpoint (50%) and then three levels lying between them at 61.8%, 38.2% and 23.6%. These should be the points where support or resistance increases.
  • Elliot wave: this tool centres on the theory that every action is followed by a reaction, and that every impulsive move in the market is countered by a corrective one. The idea is that the psychology of traders and the tendency to follow wider trends results in trading that produces waves on the gold chart and that, after five waves, a larger impulsive wave appears before a three-wave corrective phase. The first five waves form the impulsive wave, moving in the direction of the main trend. The subsequent three waves provide the corrective waves. The use of corrective waves can involve the cross-study of Fibonacci retracements.

Read more about pivot point trading strategies

8. Gold trading strategies: other technical indicators

There are other technical tools that can be used by gold investors to calculate other factors in order to help predict where the future price is headed. Some measure the momentum behind any trends that have emerged, others evaluate the level of volatility in the market.

Below are some of the notable technical indicators used to trade gold:

  • Relative strength index (RSI): this index is an indicator of momentum that compares the average gain made when prices have risen over a set period of time, for 14 days as an example, compared to the average losses made in the same period. This provides an idea of whether gold is set to become overvalued or undervalued in the near future.
  • Stochastics: the stochastic oscillator also helps gauge the momentum behind the price. The theory behind stochastics is that prices that have been trading in an uptrend throughout the day usually settle at the upper end of that day’s price range, and those experiencing a downtrend will close the day at the lower end of the range. Operating within a range of 0-100, a reading below 20 signals an oversold market while one above 80 shows signs of a market that is overbought. This is often used in conjunction with the RSI.
  • Average true range (ATR): ATR measures the volatility of a trend but does not identify trends itself. ATR is a type of moving average that compares the highs and lows of gold over a set period of time with the most recent closing price, producing the ‘true range’ for the five most recent trading days, which is then averaged out to produce the ATR.
  • Bollinger bands: this is a helpful analysis to identify when sentiment and prices will change direction within a range-bound market. This identifies three important levels that put the current price into perspective: the trendline (where it is heading now), the upper line (where resistance will be met), and the lower line (where support will kick in). These three levels provide a range in which to trade in to help signal where the turning points are.

All of these indicators are used in other markets such as forex. You can read more about using these indicators in the forex market here.

9. Investing in gold ETFs and gold producers

In addition to taking positions on the price of gold itself investors also have the option of looking into gold ETFs and mining companies, either as alternative securities or to help form a broader picture of the gold market through both fundamental and technical analysis as mentioned earlier.

The ETFs in this case are funds that hold interests in one principal asset: gold, usually through derivative contracts that are backed by the metal. This means that the value (and therefore the share price) of gold ETFs is directly influenced by movements in the gold price, giving investors a way to trade gold but in the same way they do a stock rather than a commodity.

The share price of stocks that mine gold is also directly correlated with movements in the gold price, but the strength of the correlation is nowhere near as tight as it is between the metal and gold ETFs. This is because there are many other reasons investors can drive the price of a gold mining stock up or down, regardless of where the spot price of gold has moved. Gold prices could be heading higher and the share prices of the rest of the major mining stocks could be following suit, but if that surge upward coincides with one gold miner releasing poor results or announcing operational issues then it is often the case that the miner will not benefit from higher gold prices like the rest of the market, because of the overriding problems. Quite simply: more drives gold miners than just the gold price, making it a more complex and potentially risky way of gaining exposure.

However, this is not to say that gold mining stocks do not have a role to play. Movements in gold prices are still the main reason for the share price of a gold mining company to fluctuate on a day-to-day basis, and it is often the case that these mining stocks will move before the actual gold price does. If miners are falling in early trade then it could be a sign that the price of gold will follow suit soon after. This makes companies like Fresnillo and Randgold in the UK helpful stocks to follow, regardless of what gold trading strategy is adopted. Equally, gold-linked indices follow a similar pattern, such as the FTSE Gold Mines Index Series which tracks all gold mining companies that have a sustainable and attributable gold production of at least 300,000 ounces a year and derive 51% or more of their revenue from mined gold.

Find out more about indices trading

Below is an example of how gold mining stocks follow the movements in gold price – but not religiously. Fresnillo’s share price largely tracked the movements of gold until two years ago when it recorded gains outstripping gold prices.

Conclusion: gold is used as insurance when times are uncertain

While there are many drivers of the price of gold, it all boils down to sentiment in the rest of the market, and movement is often a reflection of whether financial markets are in risk-on or risk-off mode. Technical analysis is predominantly used for short-term traders, while fundamentals often prove helpful for those taking a longer-term view, making a combination of both the ideal package of analysis tools for gold traders. However, the longer-term trends of gold – whether up or down – are often a reflection of how anxious markets are feeling about a whole host of things: the geopolitical situation, the volatility in forex or equity markets, or just the overall outlook of financial markets as a whole.

The information on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG Bank S.A. accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer.

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