Silver and gold have been interesting to watch since the beginning of the year. We’ve seen violent inter-day swings and failed breakouts. The current trading setup in silver, however, is very bullish for this week and the rest of February. If this setup succeeds it will represent a reversal in the price on a monthly basis and a new trending move.
For this article I’ll use the iShares Silver Trust ETF (NYSEARCA:SLV) to assess price. I will also be using trading quantitative techniques that I discuss in my book The Big Trade: Simple Strategies for Maximum Market Returns. My system is predicated on assessing the probability that the next bar will be higher or lower than the previous one and it uses only the stock’s past trading data to calculate the probabilities. In this case the last bar for silver was a bullish up bar. What we are looking for now is the probability that this week’s bar will be another up bar and then look for the probabilities of the following conditions:
- That SLV will break the previous week’s high (marked #1)
- That SLV will close the week above the high from the week previous to that. (marked #2)
Closing above bar #2 would constitute a 2 bar reversal pattern that would be a clear breakout sign from the 7-week consolidation whose range is defined by the high from peak two and the lows from mid-December (gray box).
One of the key concepts of The Big Trade is that classic opening range theory – a period of time where bulls and bears define the trading range – can be reimagined as a slice of price. By looking at the impulses within a bar we can calculate the probabilities of the trade moving towards and through the top or bottom of a consolidation. Here’s what we know about SLV for bars #1 and #2:
So, with that in mind we can ask the question of SLV (assuming SLV opens near the Close of #1):
- If SLV moves up $0.10, up to $30.88 then what is the probability of it moving to $31.25, through the Bar #1 high of $31.22? The answer is 62.0%
- If SLV moves down $0.10 to $30.68 then what is the probability of it moving to $29.70, through the low of Bar #1? The answer is 29.0%
So there is a better than a 2:1 chance that SLV will break the previous week’s (Bar #1) high versus breaking the previous week’s low. Those are good odds. Also, if Bar #1’s high is broken it reinforces the bullish probabilities because the chance of SLV breaking both the High and the Low of the previous bar is just 8.9%. Therefore, a daily close above $31.22 would be a very strong signal of bullish impulses in the market overwhelming bearish impulses – the supply of buyers is stronger than the supply of sellers at the marginally important price points.
The Follow Through
Here’s where SLV’s potential gets interesting. If Bar #1’s high is broken what is the probability of Bar #2’s high being broken? 79%. And the probability of SLV falling back to $29.72 is just 8.9%. That’s a setup which says that as the price rises the probability of it continuing to rise goes up as well.
Moreover, if Bar #2’s high is broken it would then create the same bullish breakout on the monthly chart.
A close in February above the December high should be seen as a reversal signal. The probabilities for SLV on a monthly basis look like this:
- Break previous (Bar #2) high? 86.7%
- If Bar#2 high is broken, chance of Bar #3 high being broken? 56.4%
To break the December high SLV would have to move $1.78. If that happens in these early weeks, and we’ve looked at the strong probabilities of that occurring, then that would constitute a very average move for SLV to move above its previous high during a month – the average is $2.00. Moreover, it sets up a potential large breakout move because the average monthly range (high to low) is $3.90, which would put SLV in range of an even longer multi-month breakout at $34 in March.
One of the hardest things for people to let go of is the idea that markets are predictable. They are not. They are probabilistic. This analysis – due to space constraints – cannot cover all of the background affecting the silver market. Fundamental analysis is a different discussion but equally important. In my experience it is the marriage of these quantitative techniques with strong fundamental analysis that creates the best opportunities for great returns. This setup in silver is not perfect but it is strong enough that it is worth exploring and watching as February progresses.
By Peter Pham Feb 04, 2013