Gold is one of the most traded commodities in the financial markets. It’s grown in popularity partly because it is commonly used as a hedge against inflation, market instability, and geopolitical factors.
XAU/USD is the most popular pairing offered by brokers and traded daily. Brokers offer futures contracts in this case that allows people to speculate on the prices of the actual commodity. In addition to the futures contract, people also trade stocks that offer exposure to the precious metal.
It is possible to buy the physical bullion to try to profit from its appreciation. By purchasing the physical commodity, one assumes ownership of the commodity instead of just speculating on prices, as is the case with futures contracts.
A gold futures contract is a legally binding agreement that dictates the delivery date of the precious metal and price. A centralized exchange standardizes the contracts, setting up the quantity, quality, and time of delivery.
With futures contracts, traders essentially take two positions, either long (buy) or short (sell). A long position allows traders to profit on the prices of the yellow metal increasing. In contrast, a short position will enable traders to profit from declining prices.
Futures contracts also stand out partly because they trade in centralized exchanges. Additionally, they can be traded on margin, whereby one can manage a high market value product with only a small amount of money. In this case, one only requires a small amount of capital to speculate on price.
Understanding factors that affect gold prices
An effective gold trading strategy must take into consideration factors likely to affect sentiments consequently trigger price fluctuations.
US dollar factor
Gold is inversely related to US dollar value. Similarly, whenever the greenback is strengthening, the precious metal price tends to decline. The reverse is true. Likewise, in times of a stronger dollar, traders resort to selling the yellow metal in the market and only buy on dollar weakness.
Monetary policies passed by the Federal Reserve have a significant impact on how the precious metal trades. Whenever the FED increases, interest rates, demand for interest-bearing asset yield such as bonds increases. In this case, investors will buy bonds and shun the bullion to take advantage of the prospects of high returns.
Whenever the FED cuts interest rates, demand for bonds decreases, given the reduced prospects of generating returns from yields. Likewise, gold tends to outperform and appreciates in times of low interest rates.
Economic data in the US paint a clear picture of the health of the US economy. A stronger US economy supported by low unemployment rates, job growth, and manufacturing expansion causes the US dollar to strengthen across the board. Gold prices tend to tank in times of economic growth and stability, given the stronger dollar factor.
Central bank reserves
Whenever central banks move to diversify their monetary reserves, they often turn to bullion. The increased demand amid low supply often triggers a spike in prices. Whenever central banks are not buying as they ought to, the net effect is usually a decline in prices.
The rise in prices of goods and services tends to influence precious metal prices. In times of rising inflation, gold prices tend to increase while lower inflation weighs heavily on prices. Prices of goods and services tend to increase in times of economic growth and expansion.
A significant increase in money supply causes the purchasing power of the dollar to drop significantly. As the dollar weakens, traders turn to the bullion to hedge against the high inflation.
Uncertainty safe haven factor
Gold is a safe haven in the financial markets. In times of economic or political uncertainty, investors shun riskier bets in favor of the yellow metal. Similarly, it tends to appreciate in times of uncertainty, given the capital inflows that come into play.
Buying and selling
Once you have mastered the factors that cause the precious metal prices to fluctuate, it is important to know when to buy and when to sell.
Gold, like any other financial asset, has seasonal patterns that give rise to trading opportunities. The best time to enter long positions on the precious metal is in January, February, August, September, November, and December.
During these months, the bullion price return has always proved to be above average increasing the prospects of generating significant returns.
Wait for gold retrace
To profit while trading gold, timing is essential. It is important to know when to enter a long or short position once a seasonal pattern or trend is identified. In case of a long-term uptrend, it would be wise to wait for the price to correct to the 0.618 level on the Fibonacci retracement tool.
Once the price bounces off the 0.618 retracement tool with a strong bullish candle formation, it would be the ideal time to enter a long position.
If the long-term trend is bearish, it would be wise to wait for the price to bounce back to the 0.618 level to enter a short position.
Buy at support and sell at resistance
Long and short positions should only be opened at support and resistance levels to generate optimum profits from a trade.
If the price of gold is trading at support with the long-term trend signaling bullishness, triggering long positions would increase the prospects of generating optimum profits.
Stop loss is important
There is no perfect trading strategy that would guarantee returns 100% of the time. Therefore, it is important to implement risk mitigation. A stop loss is essential for any trader looking to generate optimum profits and keep losses low if something goes wrong.
A stop loss order would be best placed a few points below the entry point in case of a long position and few points above the entry position in case of a short position.
In order to generate optimum returns trading gold, it is important to master the factors likely to trigger price movements. It is also important to master how the market is likely to react to such factors. Once you master the factors, it is important to only enter trades at support and resistance levels, especially after a 61% pullback on the Fibonacci retracement tool.