While many eyes in the trading world have been playing the watching and (new-high) waiting game with the S&P 500 (SPX), futures traders have been watching the metals sector fall out of bed recently. For example, after trending steadily lower since mid-April, December gold futures (GCZ18) dropped below $1,200/ounce for the first time in a long time last week, ultimately reaching $1,167.10 on Thursday before:
1. Rebounding to close in the upper portion of the day’s range.
2. Closing higher on Friday, and making a low more than 1% above Thursday’s low.
3. Following through to the upside yesterday.
Just another false bottom and temporary bounce? Maybe, but the daily chart above shows the result of the price action surrounding last Thursday’s low was a modest “spike” with the following general characteristics:
1. A day that makes a new n-day low (10 days, 20 days, 60 days—the longer, the more potentially significant the low) that is also notably lower than the previous day’s low. (In this case, it was around 1% lower.)
2. The next day has a notably higher low (again, in this case it was around 1%). The more separation between the low bar and the lows of the preceding and following bars, the bigger the spike, and, according to some traders, the more potentially significant it is.
The implication: The price dropped at least relatively sharply to a new low, but then reversed and made an upside push of a similar magnitude—a possible sign of a changing of the guard from bears to bulls that could produce a continued bounce or reversal. The highlighted bars in the chart are similar to the pattern that unfolded last Wednesday-Friday. In each case, gold moved higher for at least a few days after the pattern completed.
Although many chart traders consider bigger spikes more reliable indicators of market reversals, this type of price action isn’t about magically identifying a market’s absolute bottom and trend reversal point. (All you have to do is look at gold’s price action over the past three months to appreciate the licking a lot of bottom pickers have probably taken.) But they do offer points at which at least temporary rebounds are possible, especially in markets that have been in extended or sharp downtrends, and are potentially oversold.
Also, they allow traders to define risk very easily: More than a small or short-lived move below the low of the spike means the market might have more momentum in store for that direction. In this case, gold bulls will likely tolerate a test of that low, but not much more.