Best gold trading strategies

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

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.