Have we seen a true double top in gold?

published 16 September 2011

Last Friday, when I last wrote on the potential topping pattern in gold, I wondered if the two tops at the $1,920 area represented the end of the incredible gold bull market.

(Click on the chart for a larger version)

Recall that from the very long-term chart, I had identified a convincing tramline pair, where the upper tramline passed around $70 above the $1,920 area.

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Obviously, this would be a terrific upper target.

But I had my doubts that gold would make it.

As I have been emphasising all along with gold, the long trade was getting very crowded. In other words, just about everyone who was going to buy gold has probably already done so.

Bullish sentiment measures have been off the scale for some time, and I had not read a bearish article for many months.

We all know the 'fundamental' reasons for this trade, of course the relentless degradation of world currencies.

But the most dangerous thing a trader/investor can do is to jump on board a trend late in the day after being convinced, by all the extreme negative news about the dollar, that they must own gold.

The early birds, who saw the potential years ago, took positions against the prevailing opinion, and have been rewarded handsomely.

But it is my guess that there are very few of these traders compared with the numbers having jumped on board in the last year or so.

If a trader today can see the potential (in the other direction) early in the trend, they may be similarly rewarded.

The bulls are running scared

With the market down by around $150 in 11 days, many of the recent converts will be under water (or have jumped ship, nursing losses). The element of doubt is creeping into the bullish camp!

OK, here is the chart as of this morning:

(Click on the chart for a larger version)

I have drawn a good-looking tramline with several excellent touch-points both from above and below the line.

This morning, the market has broken below it a bearish sign. The key level of support is the major low of $1,700 made on 25 August.

Let's look at the close-up chart:

(Click on the chart for a larger version)

From the $1,920 top, I have drawn my upper tramline, passing through the other two highs.

My centre tramline passes through many excellent touch points, and my lower one passes right through the major 7 September low.

These are good tramlines.

This morning, the market is hovering right on the centre tramline. If it can break decisively down from here, my lower tramline becomes my major target.

And because there is an overwhelming abundance of weak longs, we could well see a cascade of selling.

The trend confirms my suspicions of a double top

So how am I doing with my trade from last Friday? Here is the chart as of this morning:

(Click on the chart for a larger version)

I have drawn the tramlines from last Friday. My 'plan A' was to short if the market made it to my upper tramline.

As you can see, it did not make it, so I had to resort to my 'plan B', and shorted on a break of the lower tramline at $1,865.

My protective stop was at $1,885, and followed my 3% rule.

As the market dropped below $1,840, I lowered my stop to break-even, following my break-even rule.

OK, I have a nice short position with stops at break-even.

The market is knocking on the centre tramline and there is a potential small positive momentum divergence forming. The potential is there for a decent bounce.

But as of this morning, the trend is down and has vindicated my idea that we have a genuine double top in place.

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John is is a British-born lapsed PhD physicist, who previously worked for Nasa on the Mars exploration team. He is a former commodity trading advisor with the US Commodities Futures Trading Commission, and worked in a boutique futures house in California in the 1980s.

He was a partner in one of the first futures newsletter advisory services, based in Washington DC, specialising in pork bellies and currencies. John is primarily a chart-reading trader, having cut his trading teeth in the days before PCs.

As well as his work in the financial world, he has launched, run and sold several 'real' businesses producing 'real' products.