Technical Analysis Signals Gold Breakout

March 29, 2010 | By | Reply More

Are we about to eat our words? Regular readers will know that we do not have a very high opinion of technical analysis as a priority tool in forecasting the movement of stock, commodity and forex markets in the longer term.

We acknowledge that it has an important influence insofar as many financial institutions thru to small traders alike base their buy/sell/hold decisions on one or more of the myriad of chart patterns, trend lines, support and resistance, moving averages, etc.etc that are available together with their preferred time frames.

Apart from the fact that charts record historical movements and it is unproven that history repeats itself, at least in detail, many of the chart signals when analyzed will contradict each other.

It helps us to think of it as a chicken and an egg situation. Did the chart patterns signal a market move first or was the market move initiated by fundamental reasons, however obscure.

Today gold has made us rethink our attitude to technical analysis, or at least in part.

It would be a very stupid investor to ignore the influence that chart analysis has on the markets. It is our opinion that clues to the possible shorter term future movement of a market are contained in the most simple chart tools.

Trend lines, 50 and 200 day moving averages and volume, with a sneaking look at Bollinger bands, are our preferred clue givers, not least because traders who use technical analysis as their principal weapon in the market war zone will be reacting to one or more of these along with their more exotic and ambitious technical preferences.

In other words if there is no specific fundamental reason for a movement then the technical boys may catch the rest of us on the hop.

Having put our point of view we must now admit to a growing belief that there is another chart pattern that over the course of time seems to rate a better than 50/50 success rate, discounting where possible that a fundamental reason has had little or no influence.

We refer to the ‘head and shoulders’ pattern. For those unfamiliar with this pattern, it can develop over any length of time although a time span of less than a week should be treated with caution, unless the target is going through an exceptionally volatile period.

Easy to recognize, the pattern forms at the left shoulder, falls to the neckline, then rises to the head and descends again to the neck line before rising to the right shoulder when the time to act arises. The shoulders should be roughly in line and the neckline represents support. In this case a strong signal to sell or go short has developed when the neckline is broken through to the downside.

In the case of gold we are now in the right shoulder of an upside down or reverse ‘head and shoulders’ pattern indicating that the next move for the metal is up.

To measure the likely, (we prefer possible), price rise or fall, measure from the top of the head to the neckline). We only use this as a possible target as very many conflicting factors can occur but it is helpful in deciding upon our `get out of the trade` profit target and setting stop losses.

There is no shortage of books and websites that give information and advice on interpreting chart patterns and analysis for those that want to delve into the subject. Wikipedia makes a good starting point as it shows some good examples and keeps it simple!

Right now the ‘upside down head and shoulders’ is signaling a gold rise to circa $1250 an ounce when the neckline is broken to the upside, but then again it is only an historical indicator.

But as it is one of the most simple and popular patterns, it is not unlikely that it may trigger a renewed wave of buying to push gold above its historical high, particularly if this week’s economic news is not good.

You see we are back to fundamentals again!!

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