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After The Big Drop, Is Silver A Buy?

05/09/11 08:58:35 AM
by Mike Carr, CMT

Silver fell more than 20% last week, and bottom pickers must be wondering if it's due for a bounce. Testing says probably not.

Security:   SI
Position:   Sell

Trading is a game of probabilities, and our objective is to use historical data to try to find an edge in the markets. However, emotions are difficult to ignore, and after a big drop, an understandable emotional response is to expect a quick recovery. Silver delivered a big drop last week, falling more than 30% from high to low. Drops like this are unusual, but not unheard of.

For perspective on what happens next, I tested to see what prices did the week after a 30% decline in 90 futures markets with data as far back as 1968. There were more than 2,000 trades to demonstrate that futures markets are very volatile. Half the time, prices were up the next week; the percentage of winning trades was actually 50.8%. It's actually a tradable system, with a profit factor of 1.2 and reasonable drawdowns, according to the test results.

Looking at the returns a little closer, we see that the worst drawdown occurred in the early 1980s, after a major commodities bubble burst. Figure 1 shows that the drawdown would have been difficult to trade through at that time, and few traders could suffer through that period with confidence that buying dips was a winning strategy.

FIGURE 1: SILVER. The drawdown in the early 1980s wiped out 10 years of trading gains.
Graphic provided by: Trade Navigator.
Since 2000, the system has done much better. It's only had one down year, but trading frequency has declined sharply. Specific to the silver market, we don't have any trade history to go on.

After 15% drops, silver has seen a bounce the next week, and lower lows in the next month. With history as a guide, it's probably best to avoid new long positions in silver for now and take advantage of any recovery to get out of open trades.

Mike Carr, CMT

Mike Carr, CMT, is a member of the Market Technicians Association, and editor of the MTA's newsletter, Technically Speaking. He is also the author of "Smarter Investing in Any Economy: The Definitive Guide to Relative Strength Investing," and "Conquering the Divide: How to Use Economic Indicators to Catch Stock Market Trends."

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Date: 05/11/11Rank: 1Comment: Submitted too late for consequential trading action.

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