The Top 10 Rules for Trading the Precious Metals Markets

My mission is to help you become a more successful trader/investor in the precious metals markets (and other markets, too). I want to emphasize to you the importance of having a trading plan of action that includes a visual trading checklist. Below are my Top 10 rules on my metals market trading checklist. .

1. Is the price trend in my favor on a trade? I've told Kitco readers for years that this is my No. 1 trading rule. If the price trend of the market is not in the direction I am going to trade that market (in my trading timeframe), I'll likely pass on a trade. I'm a trend trader, and the "trend must be my friend" before I make a trade.

2. Is this potential trade within my financial risk tolerance? To be a successful trader, you not only have to have winning trades, but you must survive the more numerous losing trades you are likely to encounter. If you see a potentially profitable trading "set-up," but the market is too volatile, you should probably pass on the trade because of the potential for a big drawdown or even a margin call from your broker.

3. What is the potential risk-reward ratio of the trade? Your risk-reward ratio in a trade should be at least two to one. In other words, if your risk of loss is $1,000, your profit potential should be at least $2,000. Anything less is not worth making the trade.

4. Has there been a price “breakout” from a trading range on the chart? One of my favorite trading "set-ups" is when prices have been in a trading range on the chart--between key support and resistance levels--for an extended period of time (the longer, the better).  This type of trading range is also called a congestion zone or a basing area. If the price "breaks out" of a range (above the key resistance or below the key support), I like to enter the market--long on an upside breakout or short on a downside breakout. A safer method would be to make sure there is follow-through strength or weakness the next trading session--in order to avoid a false breakout. The trade-off there is that I could be missing out on some of the price move by waiting an extra trading session.

5. Is there a potentially good entry point if the trade looks good? Entry points in trades most times should be based on some type of support or resistance levels in a market, as determined by studying the chart of your trading timeframe. If I see a potential set-up for a long-side trade, I will wait for the market to push up through a resistance level and begin a fledgling price uptrend. Then, if I do go long (buy), I'll set my sell stop order just below a support level that's not too far below the market. And if the trend does not develop and the market turns back south, I'm stopped out for a loss that's not too painful. Another way to enter a market that is trending (preferably just beginning to trend) is to wait for a minor corrective pullback in an uptrend or an upside correction in a downtrend. Markets don't go straight up or straight down, and there are minor corrections in a trend that offer good entry points. The key is to try to determine if it is indeed just a correction and not the end of the trend.

6. Is there a support or resistance level nearby, at which I can set a protective stop when I enter the trade? This is your exit strategy, and is one of the most important factors in trading markets. On when to get out of a market, I have a simple, yet very effective method: Upon entering a trade, if I place a sell stop below the market if I'm long (buy stop if I'm short), I know right away how much money I will lose in any given trade. I will never trade without employing stops. Neither should you. Remember that you can also use “mental stops” that are not actual stop orders placed with your broker. Thus, I will never be in a trade and have a losing position and not know where my exit point is going to be. I prefer setting tighter stops because I'm not rich and want to survive financially to trade another day.

7. Do "fundamental" market factors raise any warning flags? Those who have read my features know I base the vast majority of my trading decisions on technical indicators and chart analysis--and also on market psychology. However, I do not ignore certain fundamentals that could impact the metals markets I'm trading. Neither should you. There are U.S. government economic reports that sometimes have a significant impact on precious metals markets. Associations also release reports that impact markets. Even private analysts' estimates can move markets. I make it a priority to know, in advance, the release of any scheduled reports or forecasts that have the potential to move the market for which I'm thinking about trading. I don't like surprises when I am in the middle of a trade.

8. What do computer-generated indicators show? (Relative Strength Index, moving averages, etc.) Some traders use the Relative Strength Index (RSI), Slow Stochastics or other computer-generated technical indicators solely for determining entry and exit points. I do neither and here’s why: I consider these computer-generated technical indicators to be secondary, yet still important, trading tools. I will use these “secondary tools” to help me confirm or reject ideas that are based on my “primary tools”--which are basic chart patterns, support and resistance levels and trend lines.

9. Do volume and open interest in futures markets provide any clues? Most veteran futures traders agree that volume and open interest are also "secondary" technical indicators that help confirm other technical signals on the charts. In other words, traders won't base their trading decisions solely on volume or open interest figures, but will instead use them in conjunction with other technical signals, or to help confirm signals. As a general rule, volume should increase as a trend develops. In an uptrend, volume should be heavier on up-days and lighter on down-days within the trend. In a downtrend, volume should be heavier on down-days and lighter on up-days. Changes in open interest also can be used to help confirm other technical signals. Open interest can help the trader gauge how much new money is flowing into a market, or if money is flowing out of a market. This is helpful when looking at a trending market. Another general trading rule is that if volume and open interest are increasing, then the trend will probably continue in its present direction--either up or down. And if volume and open interest are declining, this can be interpreted as a signal that the current trend may be about to end.

10. What is the prevailing general opinion of the market? (Possible contrary-opinion thinking.) When I was working on the trading floors of the major futures exchanges, traders would many times "fade" (or trade against) the featured articles on commodities in the major newspapers. They figured that if the general press had picked up on a market (such as a drought driving grain prices higher), then that uptrend must be about over. Contrary opinion in the trading business is defined as going (trading) against the popular or most widely held opinions in the marketplace. This notion of "going against the grain" of popular market opinion is difficult to undertake, especially when there is a steady drumbeat of fundamental information that seems to corroborate the popular opinion.

If you've read books on trading markets, most will tell you to have a trading plan and stick with it throughout the trade. A main reason for this trading tenet is to keep you from being swayed or influenced by the opinions of others while you are in the middle of a trade. Popular opinion is many times not the right opinion when it comes to market direction.

That’s it for now. I hope you enjoy my Kitco educational features. More to come!

Read more by Jim Wyckoff