A 1-2-3 Bounce In Gold

05/31/06 09:16:25 AM

by David Penn

A cycle swing sets up a short-term low in unhedged gold mining stocks. The 1-2-3 trend reversal helps traders and speculators take advantage of it.

Security: $HUI
Position: N/A

Based in part on the cycles analysis of Tim Wood (cyclesman.com), there is a reasonable expectation that gold and gold stocks will bounce in the late May–early June time frame. This low is not the sort of intermediate low that can be expected in gold later in the summer. By comparison, the low that stocks are trying to make at the current time is both short term and intermediate term (based on both daily and weekly cycles).

When cycles or other technical studies suggest that a reversal in trend might be approaching, there can be a benefit in looking to shorter-term time frames in order to get the best entry possible. During a seminar at the Chicago Traders Expo in 2005, a hedge fund manager presenting alongside The Market Vu Show (themarketvushow.com) pointed out how he liked to spot potential trading opportunities in the daily chart, then zoom in to hourly and 15-minute charts in order to minimize risk by relying on intraday support and resistance levels that might otherwise go unnoticed.

If we start with the thesis that gold is making a short-term low and bring to that thesis an analysis of intraday trends in gold mining stocks that typically, but not infallibly, lead the price of gold, then we should be able to spot any early opportunity—if any—to pick up gold shares as they swing higher.

FIGURE 1: AMEX GOLD BUGS INDEX, HOURLY. A swing rule projection from the recent lows in the $HUI suggests an upside bounce that could test the 370 level over the next few days.

Graphic provided by: Prophet Financial, Inc.

Here, the 1-2-3 trend reversal approach provides some guidance in terms of analyzing the bottoming process in the AMEX Gold BUGS Index. Recall that the 1-2-3 trend reversal method requires first a properly drawn trendline. For purposes of this method, that trendline is drawn by connecting the highest high in a given time frame with the lowest high that is immediately before the lowest low. The trendline in the chart of the $HUI in Figure 1 is an example of such a trendline.

The "1" in the 1-2-3 trend reversal is the initial trendline break. The "2" refers to the effort to reestablish the trend by making a new low (or new high, in the case of a broken uptrend). The "3" stands for the move beyond the resistance (or support, in the case of a broken uptrend) established by the market during step 1 of the 1-2-3 trend reversal.

By applying this analysis to the hourly $HUI, we can see that both stages 1 and 2 appear to be complete. The $HUI has broken its downtrend and established a key resistance point (1). The $HUI has fallen back in a failed attempt to set a new low (2). Most recently, the $HUI has been moving higher toward a test of the resistance point established in stage 1.

FIGURE 2: AMEX GOLD BUGS INDEX, HOURLY. Is Tuesday "test resistance day"? Both advances off the lows have so far failed to reach a Fibonacci 38.2% retracement level just north of 340.

Graphic provided by: Prophet Financial, Inc.

Should the $HUI break through the resistance from stage 1 for a successful stage 3 of the 1-2-3 trend reversal, it would be worthwhile to consider the upside implications of the successful breakout. In this, Stan Weinstein's swing rule is a helpful way of projecting a reasonable upside beyond the resistance level. Taking the measure of the market below the resistance level and adding that amount to the value at resistance gives a potential upside in the 365 region.

Now, 365 is an interesting area. As Figure 2 shows, 365 makes a Fibonacci 61.8% retracement level of the $HUI's entire correction from mid-May. Having not reached yet the more modest 38.2% retracement level in any bounce so far, the $HUI might not make it to the 61.8% level in a single bound. But for those inclined to ride any move higher in the gold shares at the present time, 365 looks like a more than reasonable aspiration.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

Title:	Technical Writer
Company:	Technical Analysis, Inc.
Address:	4757 California Avenue SW
	Seattle, WA 98116
Phone # for sales:	206 938 0570
Fax:	206 938 1307
Website:	www.Traders.com
E-mail address:	DPenn@traders.com
Traders' Resource Links
Charting the Stock Market: The Wyckoff Method -- Books
Working-Money.com -- Online Trading Services
Traders.com Advantage -- Online Trading Services
Technical Analysis of Stocks & Commodities -- Publications and Newsletters
Working Money, at Working-Money.com -- Publications and Newsletters
Traders.com Advantage -- Publications and Newsletters
Professional Traders Starter Kit -- Software