From the May 01, 2009 issue of Futures Magazine • Subscribe!

Day-trading silver with technicals

We are currently facing some of the most volatile market conditions that we have ever seen. Uncertainty in the marketplace creates this volatility and makes it difficult for the average trader to participate. Most traders find themselves getting chopped up by the violent fluctuations and then becoming reluctant to get back in. Consequently, they miss out on winning trades or are forced out due to margin calls.

The key to success in this environment is a disciplined strategy and a quick trading approach. You have to have a game plan to trade these markets. Anybody can look at a daily or weekly chart and pick a direction. However, without a disciplined strategy, you are likely to fail.

This article will provide a comprehensive overview of a few reliable trading strategies, as applied to the silver futures market. Of course, it’s always up to you to decide which specific methodology fits your risk tolerance, account size, goals, wants and needs, but being nudged in the right direction can help you down the right path.

TECHNICAL TOOLBOX

Most traders are primarily technical. That is, they study the long- and short-term history of price itself to forecast future price moves. However, it’s also a good idea to be aware of a market’s fundamentals, the supply and demand situation, as well as the influence of related markets. Such a broad outlook helps traders to better pinpoint entry and exit points, and to help interpret what they are seeing on the price charts, such as momentum or overbought and oversold conditions.

Here are some commonly used general technical indicators:

• Moving averages: the average price for a particular time period.

• Relative strength index (RSI): measures how strongly the market is moving in a particular direction (used mainly to gauge overbought and oversold conditions).

• Stochastic: used to determine momentum’s direction.

• Moving average convergence-divergence (MACD): a single indicator that combines the information from multiple moving averages.

All of these indicators can be used in the same trading approach. In demonstrating the intraday application of these tools, it seems only appropriate to use silver, where it has been difficult to buy and hold a position lately due to extreme volatility.

Begin with a daily chart to determine the short-term trend. This suggests whether you should buy a pullback or go short on a rally. If the short-term trend on the daily chart has been down, you should be more inclined to sell a rally at a test of resistance. Major resistance for a day trade will be found first on the 60-minute chart at a level of old support, or at price levels that represent prior tops in the market.

Next, examine a 10-minute bar chart. This helps determine if the relevant price levels are realistic entry points in the context of the day’s trade. Once the level of preferred entry is determined, the next step is to devise an exit strategy and realistic objective.

The first step here is to determine how much risk is involved. In other words, look for the next resistance level just in case the first level of resistance does not hold. Now, determine what the profit objective is for the trade. For example, if you were looking to go short, this would be the next support level on the downside. As a rule of thumb, you should not risk more than you’re trying to achieve. When that strategy works, it works by chance, and it is never successful over the long term.

Price entry is made, whether long or short, when the price is near the key level and the MACD crosses into a buy or sell signal on the 10-minute chart.

“In and out” is a perfect example of a reasonably quick long day trade. The first vertical line marks where the buy signal is triggered and the lower horizontal line marks the entry price. Ideally, you would offset near the upper horizontal line, which should serve as resistance because it was old support. Assuming that’s how you worked the trade, you would have earned a quick 28¢ per ounce profit, or $1,400 per contract. If you would have waited for the MACD to give you a sell signal, you would have exited the trade on the further right vertical line for roughly a 20¢ per ounce profit, or $1,000 per contract.

PIVOT APPROACH

Another strategy for day-trading is the pivot point system, a method commonly used by floor traders. The pivot points are a mathematical calculation of the previous day’s high, low and close prices to get support and resistance levels for the following day. Therefore, with this system or strategy you already have your key price levels; no price charts are needed.

There are a variety of calculations used for pivot points, but these are the most common formulas:

Pivot level = (high + low + close) / 3

Support 1 = (two x pivot) – high

Resistance 1 = (two x pivot) – low

Support 2 = pivot – (high – low)

Resistance 2 = pivot + (high – low)

The strategy is to look to enter into the market as close to the pivot level as possible. If the market price is above the pivot, you would go long on a pullback to a price close to the pivot. You then would look for a test of Resistance 1 as your first partial profit objective; here, you would offset half your long position. Resistance level 2 then becomes your final profit objective for the day. Once the market goes up to Resistance level 1, you would move your stop up to a breakeven on the remainder of your position.

If the market price is below the pivot level, then you look to sell as close to the pivot as possible. Use Support 1 as you first profit objective and Support level 2 for the final exit point, while trailing your stop accordingly as was done in the long trade example.

These daily pivot levels are extremely useful when used in conjunction with other trading strategies. They also are effective for weekly levels, which typically tend to offer a stronger support or resistance level than the daily calculations.

TRADE WHAT MOVES YOU

Another reliable short-term technical approach is momentum. Breakout trading is another term for trading momentum. It does not matter what direction the market is going — as long as it is going there quickly and targeting new highs or new lows.

The reasoning behind this approach is that if the market has enough force behind it to make new highs or new lows, then it is likely to continue moving in that particular direction. This is a chart pattern that is easy to recognize.

On the daily chart in “Off to the races” you would have bought the May silver futures contract at just above $11.60 per ounce on Jan. 23, 2009. You can see by looking at the lower horizontal line that $11.60 was not only resistance, but by breaking it, the market would make new contract highs.

For further confirmation, the MACD has been applied to the daily chart, and this indicator also gives a buy signal. Assuming you used this to pick your entry and exit points; you would have exited the trade on Feb. 26 for a nice profit of $2 per ounce, or $10,000 per contract, without ever experiencing a drawdown on the trade. This is an extremely rare level of success, but it demonstrates the possibilities when everything goes right with a momentum trade.

While over the long-term both the fundamentals and technicals suggest that a long bias in the precious metals markets would be prudent, these strategies generally do work for trading both sides of the market. These also are effective methods for timing delivery of the physical underlying by allowing the investor to buy the metal at the best price possible.

Both Frank J. Cholly and Frank D. Cholly are senior market strategists at Lind-Waldock. They can be contacted at fcholly@lind-waldock.com and fdcholly@lind-waldock.com .

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