Markets I Trade: January 8, 2019

In my non-registered investment account I am developing my trend following strategy continuously. I don't pretend to have all the answers; I am always exploring and learning and I am sharing that journey with you on this blog.

All I know for sure is that I want every trade to end in three ways: a small loss, a small gain, or a large gain. I predetermine my risk on each trade and aim to make sure that risk is never exceeded.

A big focus of my trading is to expand my access to a broad range of markets while using my investment capital very efficiently. Instead of holding standard positions in ETFs or stocks, I am using LEAPS options and futures contracts.

Options and futures contracts allow me to bet on the upside or on the downside of trends with minimal penalties. They also require a small capital allocation to control a large position. Unlike with common stock or ETFs, options and futures do not require borrowing costs to short an asset.

I try to limit my investing process to liquid markets that have the highest potential for bigger price movements. This generally means using LEAPS options on the largest ETFs and using futures contracts for commodities and currencies.

Thanks to the wide range of choices in the ETF markets and the massive breadth of the futures markets, I can theoretically get easy exposure to hundreds of different assets across the planet.

To monitor each instrument I trade, I look at moving averages and volatility measurements. Although there is no holy grail indicator, looking at these tools can help paint a pretty solid picture of where the markets are going. This can improve the odds of success in trading.

Moving averages help identify the direction of trends and can help show turning points in direction. Using volatility measures makes it easy to size each position based on pre-determined exit points. High volatility markets translate to smaller positions while low volatility markets allow for larger positions.

I also look at breakouts, although I am not using them to enter or exit positions. Breakouts can be very helpful in confirming trends and seeing points of previous resistance.

Silver (SI=F)

In today's post I will share my analysis on my latest large trade in silver. I used futures contracts in this trade as the LEAPS options market on the silver ETF (SLV) is pretty thin. A single futures contract for silver gives exposure to 5,000 ounces for delivery at a future date. Most contracts are settled financially rather than being physically delivered.

I have been watching precious metals quite closely for the past year looking for an entry point. In the late summer, gold prices seem to have made a bottom which later set up my entry for the options trade on GLD.

Gold and silver often trade in tandem, but throughout the late summer and fall, silver prices kept falling while gold prices inched upwards. In late November, it required more than 86 ounces of silver to buy a single ounce of gold. That's one of the highest ratios in several decades.

Silver appears to have made an interim bottom in November and has shown strong upside movement since then. Since my entry point, my silver trade has done very well. It has jumped about $0.85 per ounce from my purchase price and I am holding exposure to 10,000 ounces.

Silver (Weekly Bar)

Source: StockCharts.com

In the beginning of September 2018, silver was oversold on a technical indicator and had a bounce up from that low point around $14.00 per ounce to about $14.90 per ounce.

Prices quickly turned down and dropped below $14.00 per ounce in early November 2018—once again touching an oversold metric. This time, selling volumes were high but buying volumes were lower on the upside than the previous move in September-October 2018.

Silver has shot up from my entry point a bit over $14.80 per ounce and volume is still pretty subdued.

Upside Optimism

  • An interim higher high was made when silver jumped over $14.90 price level in September-October.
  • Silver moved from a technical oversold period which can indicate a longer term bottom due to seller exhaustion.
  • The price moved strongly above the 10-week SMA.
  • At the end of December, the price soared up and closed above the 40-week SMA for the first time since early 2018.

Upside Caution

  • The 40-week SMA is still declining at the moment, indicating a long-term downtrend.
  • Betting on a pivot point (change in direction against the long-term trend) always has more risk than buying into a confirmed uptrend.
  • If the price continues to expand aggressively, silver could quickly become technically overbought and that would signal a good probability of a price pullback.
  • The range from $16 to $18 per ounce could see a lot of selling pressure.

Although I don't trade based on stories, silver prices have been depressed for nearly seven years. It costs more than $15 per ounce for major miners to produce silver. I don't believe prices could fall much lower than they are.

SI=F (Daily Bar)

Source: StockCharts.com

This chart shows my entry point (blue) and my current stop level (red). The price has pulled away strongly from my stop, so I will carefully monitor my risk on this trade to prevent over-exposure.

I entered this trade using silver futures contracts on the COMEX exchange for March 2019 delivery. The margin (or deposit) per contract is just US$3,600 plus any applicable paper losses.

Comments & Questions

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2 Replies to “Markets I Trade: January 8, 2019”

  1. Very interesting article, thanks for sharing Daren.

    A few questions: a) you provide your entry and stop levels, but at which point do you decide to take profit, and if that threshold is hit would you exercise only one or both contracts; b) I am not familiar with trading futures contracts – is there an educational resource you suggest to familiarize myself with the process; and c) what was your stop level on the downside, 14.6 or do these function like options where they are either in or out of the money? And in that case why do you need a stop level?

    Thanks.

    1. Daren (Editor) says:

      Aaron, I think the best way to understand futures is reading Investopedia definitions, taking some online courses (I took a few through Interactive Brokers), and watching Youtube videos. There’s a lot of quality stuff there.

      I use a Keltner Channel which is basically a combination of a moving average and average true range. I enter on the buy-side when the price jumps past the lowest point of the upper band and set my stop at the highest point on the lower band (since the previous signal change). I would sell both contracts (my entire position) when it hits this stop point. Of course the stop point climbs as the price moves up and/or volatility decreases. I would sell part of my position if the price ran too far away from my stop that my risk in the position is too high relative to my maximum acceptable risk.

      My initial stop was at $14.10 per ounce. As the price moved up, my stop has now increased to a smidge under $15.

      Futures contracts are not at all like options. If the price is $15.70, one contract is worth U.S. $78,500 (5,000 ounces) for delivery on March 2019. Until that time, you must maintain margin (you can almost think of it like a deposit) of $3,600 per contract plus enough to cover any losses owing.
      Stop losses are critical in futures contracts. If the price of silver drops down to $13 per ounce, the total contract would be worth $65,000. That means I actually lost $13,500 per contract when it sell it back into the market.

      Hope this helps!

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