What to trade

As we all know: the more liquid the market, the better our technical analysis works.  If we take this as our main criterion, then among the most attractive markets we would find commodities including oil, silver and gold. Here I would like to discuss the distinct advantages that the gold market presents to the trader. 

While gold is not an accepted payment instrument (at least not in its broadest sense), it is a de facto currency that has served humanity for 5000 years. An entrepreneur acquaintance of mine, who collected paper money of different vintages, liked to show his collection to his guests. Afterwards he would ask “Do you know what all these monies have in common?” and would follow up with the punch-line that “They are all worth nothing!”

“But this…” he would say, as he pulled a small gold bar from his pocket. 

Because of gold’s function as a natural alternative to paper money, as well as its historical role as a hedge against inflation, the amount of money and the number of players in the gold market today is unprecedented. Below you can see the gold chart over the past 10 years.

gold 10 years

The gold market, as you can see, has soaked in a very substantial amount of liquidity, and this makes it a good candidate for applying technical analysis with a very high probability of success. 

Slippage in this market is mainly caused by the greed of your broker – if the brokerage is also involved in trading their own capital, thus front-running your position –  and is not due to lack of supply or demand.  You might get quoted a price that is 50c worse than what you were expecting, but (unlike in the stock market) you should always be able to find a ready buyer for your 1000oz of gold. 

The gold market is traded 24 hour a day, Monday through Friday, with ample liquidity and almost no price gaps. This means that you could leave a position open overnight and not worry, safe in the knowledge that your protective stop order will be filled at or around the price you set. In contrast, a stock price could gap down (or up, for a short position) through your stop level thus leaving you with a very unpleasant and costly surprise the next morning.

The worse the economic outlook, and the more unstable the financial and FX markets get (which certainly seems to be the case these days), the more people will move their assets into gold. And this makes it even easier to trade.

When thinking about financial market ‘liquidity’, the analogy should not be lost on you that in many ways the price behavior of traded securities resembles the physical behavior of liquids. In the Elliott Waves section of this web site you can discover how market moves resemble waves on the sea. In this context, it becomes apparent why a trader should only look to trade in highly liquid markets.

Let’s conduct a small ‘thought experiment’. Imagine an Olympic size swimming pool filled to the brim with water. Now let’s drop a bowling ball into it. What will happen? We would expect to see a wave that travels all the way to the other side of the pool – a nice long trend, as traders would say. Now let’s imagine that there is only about an inch of water in the pool. What would happen now if we drop the same bowling ball into the water? We would see a small splash… but no big wave. In financial terms, big waves are more profitable than choppy waters, and we can only witness big waves in a big pool of liquidity.