The gold stock rally ended sooner than I thought it would.

The VanEck Vectors Gold Miners Fund (GDX) peaked a couple of weeks ago, and it was drifting lower as we headed into February. As I pointed out last week, though, the gold sector still looked bullish. The rally was hanging on by a thread. But, as long as GDX remained above $23 per share, I still liked the odds of a stronger move higher.

Well, I sure got that call wrong.

GDX closed below $23 on Friday, and it’s been a straight shot lower ever since. The stock closed below $22 per share yesterday. The gold stock rally that started in mid-December is over. Rather than exploding higher and giving us gold bugs a nice gift for Valentine’s Day, GDX rolled over and vomited into the box of chocolates.

Take a look at this updated chart…

GDX has spent the past year trading in a wide range between support at about $21 and resistance near $25. At some point, the stock will break out of this pattern and GDX will have an extended move one way or the other. Until that happens, traders can still do pretty well in the gold sector by buying near support and then selling near resistance.

The bad news for gold bugs is the recent rally ended prematurely and without the upside explosion I was hoping to see.

The good news is the swift decline over the past week has pushed the sector right back down towards support and another potential buying opportunity.

I’m not quite ready to step up and add more exposure to the gold sector just yet. As GDX gets closer to support at $21, it will provide a more favorable risk/reward setup.

Best regards and good trading,

Jeff Clark

Reader Mailbag

Yesterday afternoon in Jeff’s trading blog, Delta Direct, Jeff answered a few questions from a subscriber.

The response was thorough, so here’s an excerpt:

Man, you called the parabolic move incredibly well. I admire that analysis.

We had SPY puts that we paid $1.20 for. Yesterday, they were trading around $12. We sold them for a 67% gain (if your advice was followed perfectly). Now we hold SPY calls, which are basically worthless after 2 days.

I don’t quite understand why your idea of a parabolic move changed in 2 trading days. Parabolic up, parabolic down. Hindsight is always 20/20, but it could have been a 1000% gain on a great call is now a 67% gain followed immediately by a 100% loss.

– Jason

 

Jeff: Hi Jason. Thank you for writing.

Yes… knowing what I know today, I sure wish I had another shot at that trade. But, your version of events is missing one very important fact.

Two days after we sold the SPY puts for a 67% gain (which, admittedly, could have been a 100% gain if we held them just another hour or so), the puts we bought at $1.20 and then sold for $2.00 traded all the way back down to $0.80.

Now, I can’t tell you with 100% certainty what my exact response would have been in that situation. But, I have a long-held discipline of not allowing winning trades to become losing trades. So, there is a VERY strong probability I would have recommended selling the puts when they traded below $1.50. So, one way or another, we’d have been out of the SPY put trade before the collapse of the past three days.

Secondly, the option trades I recommend in the blog are usually designed to be very short term – lasting about a week or less. By the time we sold the puts we had held them for six days.

Lastly, and most important, most of the trades I recommend rely heavily on pattern recognition. I look for similar past situations, similar chart patterns, to provide clues as to how the patterns will resolve. In the vast majority of breakdowns from a parabolic pattern, the price bounces and forms a lower high before more significant selling begins. So, with so many technical indicators in oversold condition, and with the VIX on the verge of a buy signal, I figured the S&P was headed for a bounce. And, I recommended selling our puts – which looked like a really good decision for two days.

Then the market tanked. Instead of playing out the typical “parabolic bust” pattern and bouncing, the S&P 500 crumbled. It did something it has only done three times in my lifetime (the 1987 crash, the “flash” crash, and now). The index traded 4 standard deviations from its 9-day EMA.

That is such a rare event that I never consider it as a possibility when I’m recommending short-term trades. Doing so would likely produce losses in more than 95% of the trades. That’s a tough trade-off in order to hold out for the one “black swan” that comes around every ten years.

As for the S&P 500 call options I recommended… Man, I totally blew that trade.

Like I said, we were oversold, we had a VIX buy signal, etc. So, I liked the odds for a bounce.

The bounce didn’t happen. And I recommended selling the call options yesterday for what works out to about a 70% loss on the trade. I explained the rationale for closing the trade – even though I think the S&P will work generally higher over the next two weeks – in yesterday’s blog post titled, “The VIX and option prices.”

After the response went live, other readers wrote in…

Jeff, nice florett response to saber-carrying Jason.

– Kristian

 

Hi, Jeff. I just finished reading Parts 1 & 2 of Jason’s constructive(ish) criticism. Bottom line, if he doesn’t trust you he should not follow your work. I’ll be the first to admit, missing out on the opportunity for a “grand slam” stings but we’ve had plenty of good trades recently that have been nice “base hits” (including SPY puts trade).

No one could have known Monday would happen. Please keep up the great work; you’re on a roll. Sounds like Jason is placing too much of his capital in each trade otherwise he would not be so upset; I’m not.

– Jesse

 

With regards to your answer to Jason in the reader feedback response. Jeff, you are one class act!

– Virginia

And finally, one reader wrote in about yesterday’s featured classic…

Great article! I will do just this from now on! 🙂 How are you feeling? Any answers?

– Louise

As always, be sure to send in your trading stories, questions, and comments right here.