The Fractal Nature of Financial Markets
The first and perhaps most important thing to realize when choosing a trading strategy is to realize that, generally speaking, financial markets have a fractal nature to them, meaning that the ebbs and flows that we see on a longer term scale tend to be produced on a shorter term scale as well.
While this isn’t replicated to the extent that we could truly say was of a fractal nature, meaning that the moves aren’t identical when comparing different time scales on charts, they are fractal from a strategic point of view enough that we can call the relationship fractal.
In other words, if a trader becomes proficient with a certain time scale, hourly bars for instance, the nature of the performance of the instrument will tend to be similar enough that this proficiency can be transferred to longer or shorter time scales, 15 minute bars or daily bars for example.
While this is true generally, this does not mean that a certain time frame will not be preferable over another in terms of fit, as a certain strategy may be better suited to a certain timeframe. Traders will also often need to tweak their strategy to better fit their desired timeframe, but generally speaking, strategies are transferable, and this all has the effect of allowing the trader to choose the length of time that they wish to be involved in trades generally.
This is all the case with gold trading as well, although with some instruments like gold, one needs to incorporate greater smoothing to seek to avoid being shaken out of trades too often, where a move of a certain magnitude may be less meaningful with gold than it may be with another instrument whose price may move in a more stable fashion.
Considerations With Seeking to Trade Gold
Generally speaking, traders will decide between different instruments to trade, unless one’s capital is so significant that the opportunity costs between competing trades are very low or non-existent, meaning that they aren’t trading gold at the expense of trading something else instead.
One’s trading capital can be significant enough that one can freely trade all the instruments one seeks, at sizes that do not influence prices too much, and in this case there is no need to decide between them. For most traders though, they do have to make these decisions, and this means that to justify trading gold, the expected results would need to be better than using the capital for something else, trading a different instrument for instance.
Gold is a very liquid instrument though, which in itself makes it more desirable than most other things that we can trade. The more active of a trader that you are, the more this matters, and this has to do with keeping the ratio of the costs of trading low enough in relation to your average profit per trade.
More liquidity tends to produce tighter spreads, and the tighter the spread, the less you will pay typically to enter and exit a trade, whether you are doing so at the market or even if you are looking to trade with limit orders. If something like gold trades more actively, this means that there is more competition among buyers and sellers and this ends up providing better deals for traders.
If one is seeking to trade larger positions than one can enter into at the market, the depth of a market will matter as well, or matter more, as depth of market does affect how tight a spread will tend to be as well. If you have to pay more than the asking price, a deeper market will allow you to do so at a better price than if the market were thinner and the spread between the ask and the next price up were wider.
The fact that gold also tends to be fairly volatile is another factor that makes it more desirable to trade, as volatility is what makes trading viable. The more an instrument moves, the more potential profitability it has, as the goal of trading isn’t just to make a profit, it is to make a certain profit over a certain period.
This is true of investing as well, but with longer term trades, it is not important that it be volatile over lesser timeframes, where with trading it is required, at least to achieve a good level of profitability over these shorter timeframes.
Choosing one’s instruments to trade is a very important component of any successful trading strategy, and many traders do choose to trade gold based upon it being a fairly desirable commodity to trade, although ultimately one’s relative and comparative success with trading an instrument needs to be the ultimate decider here, measured by the bottom line.
Choosing How to Trade Gold
Choosing to trade gold in general isn’t enough, as one also needs to choose how they will trade it, and there are several options here.
One isn’t going to generally look to buy and sell physical gold to trade it, as the time involved in buying and selling bullion as well as the much higher trading costs involved isn’t going to make this either practical or even desirable.
In order to trade efficiently, one needs to be able to enter and exit positions quickly. This will limit traders to gold based securities, such as trading gold futures, exchange traded funds or ETFs based upon gold, including inverse ETFs which inversely track the price of gold, trading in stocks that are fundamentally based upon gold, or trading gold by way of contracts for difference, or CFDs.
All of these methods of trading gold allow traders to quickly place trades and have them filled, with reasonable spreads, as well as the ability to go long or short as desired. This may be less the case with gold stocks, if the stock is less widely held and therefore may be more difficult to short, although the wider spreads that some of these stocks are traded at may itself make them a lesser choice.
The futures market offers traders an easy way to speculate on both the price of gold going up and going down, and one can enter a position both long and short with the same amount of ease. While futures contracts expire, gold futures can be easily rolled over and therefore positions can be held for pretty much as long as one desires without needing to be closed out.
Traders can also buy options on gold through the futures market, although trading in options is more complex and potentially risky and traders should only consider speculating on options if they are confident that they have enough of an edge to do so profitably.
Gold ETFs are extremely popular these days, and allow traders to speculate on gold without having to open a special futures account or CFD account. One simply buys these instruments like they would any stock, and in fact what is being bought and sold is shares in the fund. Due to the popularity of gold ETFs, one can get good spreads with these trades as well.
The downside of ETFs is that they cannot be leveraged anywhere near as much as futures and CFDs, which may or may not suit a trader’s strategy. Those who are less skilled or experienced are wise to pay attention to not over-leveraging, as in this case they would be simply leveraging their trading disadvantage.
If one has a trading advantage, a positive expectancy, then it can make sense to leverage this more, but even in these cases, one needs to pay close attention to not taking on too much drawdown risk where their capital may decline excessively due to distributions of probability.
Contracts for difference trades can be placed with CFD brokers for both the cash gold market and for gold futures. Some CFD brokers offer very competitive spreads, while others may not, so it’s very important to shop around here. CFD trading also offers the ability to use high amounts of leverage, and offer even higher leverage than futures brokers, so it may become even more important to not overextend oneself.
There is a lot of skill involved in trading, which does require a period of education, but once one becomes proficient enough to be profitable, trading gold can be a very good choice as far as what to use these skills with.
Editor, MarketReview.com
Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.
Contact Monica: monica@marketreview.com
Topics of interest: News & updates from the Office of the Comptroller of the Currency, Forex, Bullion, Taxation & more.
