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How I Found The Bottom In Gold

For the second half of 2016, it looked like all hope was lost for gold.

Back in September the shiny metal had a massive move to the downside, and then recovered nearly all of those losses...

Only to have the post-election reaction bring sellers back in as it broke key support.

Yet into this bloodbath, I was able to earn consistent profits by finding an edge and using smart trade methods.

In the next few minutes, I'd like to show you how I did it.

The Selloff

Here is a chart of GLD, the most heavily traded gold ETF:

gld-1

In terms of support from previous pivot levels, there wasn't any until about $100 per share. It was just a big gaping void to the downside.

Yet, we were starting to get oversold on a statistical basis...

Here is a technical study I use called a Rolling Returns chart. It shows the performance of an asset over a specific window... in this case it is 20 days, which is 1 trading month.

gld-rolling-returns

Back in early December, GLD had sold off over 10% in a month. Looking at this chart, it appears that this hasn't happened the entire year.

So I sat back and asked myself two questions...

  1. How often does a 10% selloff happen? And...
  2. What happens after that selloff?

Answering these two questions can help me discover whether it's good risk/reward to enter these trades.

How did I answer these questions? Let's dive in.

Finding the Quant Data

Here is another chart of the Rolling Returns, but instead of looking at it over time, we stack all the values on top of each other to make a distribution.

gld-distribution-1

So you can see that this pretty much looks like a bell curve-- a lognormal distribution.

Further, you can see that we don't have a 10% selloff very often.

If we look at the statistics, we can see that the average 20 day return is right around 0.6%, and the standard deviation is right around 5%.

That means a 10% selloff is a 2 standard deviation move.

This is statistically significant and worth watching.

Moving onto the next question...

Finding the Results

I looked at how GLD performed 20 days later *after* a 10% selloff. Here are the results.

gld-distribution-2

While this isn't a huge sample size... it's something worth looking at.

The majority of the returns are positive, meaning that when the market sells off over 10%, we tend to have higher prices within the next month.

The average for this is 4.2%, and the standard deviation still sits around 5%.

Finally, the worst loss GLD had was right at -7%.

Finding the Floor

Back on December 5th, that's when we saw our GLD under 10% reading.

It was trading at 111.54.

Now just think about this... if we know that over the past 10 years the worst move was down 7%, then we can expect that to be the absolute worst case scenario.

7% off of 111.54 is...

103.73.

Simply put, anythiing between the current price and 103 offers good risk/reward for a bounce in GLD.

Now is it possible that we see a worse kind of move? Sure... but this is a commodity not a stock so it's not going to have earnings or a bad FDA event.

What's more, we were headed into the holiday trading season which meant lower volatility and higher odds of reversion.

Now the question here is... can you structure your risk in a way that makes sense?

The Option Trading Strategy

With this kind of approach, you should look at selling credit spreads to further put the odds in your favor.

In this case, it was a bull put spread in GLD.

Here was the exact order:

gld-order

Some things to pay attention to:

  1. Go further out in time. This allows you to have more "wiggle room" to manage your risk in a trade.
  2. Scale into the trade. Don't go all in when you know the natural volatility of the stock will probably put you in better prices.
  3. Don't hold to expiration-- scale out. You tempt the market gods by trying to get that last 10 cents of credit.

The analysis of GLD is where I found the trade idea... but the execution is where I find my edge.

Get this Done For You

Now you can go and do this all on your own.

You can backtest your ideas, figure out what works, maybe make a few mistakes along the way, and hopefully turn a profit on your trades.

Yet what if you could simply leverage my expertise and get profitable trade setups delivered directly to you?

I'd like to introduce you to Proactive Spreads. This is a trade service that uses our unique execution techniques combined with technical and quantitative analysis.

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by Steven Place

Steven Place is the founder and head trader at investingwithoptions.com/