Lower Prices Ahead For Gold

05/04/10 12:31:15 PM

by Alan R. Northam

Gold has been working its way higher since early February. However, a negative divergence has developed over the last month, forecasting that this market could see lower prices ahead.

Security: GLD
Position: N/A

Figure 1 shows the daily price bars of the SPDR Gold Shares exchange traded fund (ETF)(GLD). From its early December 2009 peak, GLD moved lower to form a high low in mid-December, a lower high in early 2010, and a lower low in early February 2010. The lower high in early 2010 and the lower low in early February 2010 technically put GLD in a downtrend according to Dow theory. To reverse this trend back up, the market must move above the lower high made in early 2010 to form a high high price. I have marked this requirement in Figure 1 with a red horizontal resistance line.

FIGURE 1: GLD, DAILY

Graphic provided by: AmiBroker.com.

From the lower low made in early February 2010, GLD started to rally upward forming a series of smaller waves. In mid- to late March, GLD formed a higher low, allowing for the drawing of the green upsloping trendline. Normally upsloping trendlines indicate that a market is in an uptrend. However, from a Dow theory point of view, this is not necessarily the case. An uptrend, according to Dow theory, is defined as a series of price peaks and valleys that form higher highs and higher lows. The higher low in mid- to late March satisfied part of the requirement for a new uptrend but not all of it. Therefore, the green upsloping trendline is only suggesting that a new uptrend is developing but has not fully developed. In early April, GLD did manage to break out above the red horizontal resistance line, signaling that the market had made a new higher high confirming the requirement of Dow theory that GLD had entered into a new uptrend. The moral of this story is to be careful when drawing trendlines to make sure that the market has also made a new higher high before drawing the conclusion that the trendline indicates a new uptrend in progress.

Below the price chart I have also shown the relative strength index (RSI) as a measure of price momentum. Healthy downtrends and uptrends are indicated by the momentum of price. When momentum is accelerating, the downtrend or uptrend is expected to continue. Note that from early April to early May, price formed a new higher high but RSI did not. This is an indication that price momentum is not accelerating along with price. This is an unhealthy situation and indicates that price momentum is slowing down. A reversal in RSI would signal that price momentum was actually decelerating. The slowdown of price momentum is a signal that price is ready to reverse back down. This condition where price continues to move higher but RSI does not is known as a negative divergence. This negative divergence is a forecast to traders to expect lower prices ahead for GLD.

In conclusion, before the drawing of a new trendline can be an indicator that a new trend has started, it must be confirmed by the market having made a higher low and a higher high according to Dow theory. In addition, a negative divergence is a forecast that price is ready to move lower. In our analysis, GLD is currently in a new uptrend; however, the negative divergence is a forecast that this market could see lower prices ahead.

Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.