One of the safest places to buy is on the pullback after a major rally reverses a downtrend. That was the advice of legendary trader W.D. Gann back in the early 1900s, and from my own 12 years of trading experience there are fewer strategies with a higher success rate than that simple setup. That brings us to gold and silver stocks, which have experienced an exceptional rally out of one of the biggest bear markets in history. The Gold Miners ETF (GDX) fell more than 81% from its 2011 peak to its 2016 low. Silver miners (SIL) were hit even harder, falling 84%. Junior gold miners (GDXJ) fell more than 90%.
In 2016 these sectors have soared more than 100%, and in some cases well over 200%. This on the backs of about a 30% rally in gold and a 50% rally in silver (at recent peaks). Miners are always much more volatile than the underlying commodity, making them an ideal trade for the investor willing to handle the volatility for potentially above average returns. While gold and silver are all well and good, the miners essentially act as a leveraged trade for moves in the underlying commodity.
With the major rally in place, which has reversed the prior downtrend, the pullback that ensues is usually the best opportunity to buy (other than right at the bottom….which can be hard to pinpoint). And that opportunity is fast approaching.
Two Problems Investors Face, and the Fix
Investors typically face two problems in this scenario though. With these stocks having rallied more than 100%, and in some cases individual miner stocks have rallied more than 700% in the last 8 months, investors feel the pressure to get in NOW, for fear of missing out on further upside. This fear of missing out (FOMO) is what has driven the prices higher already, but the party always ends and a big pullback begins.
The people who recently bought these stocks are failing to realize that uptrends always move in waves: big move up, move down, big move up, etc. After a big move up, the big down move will come, and has likely already begun. Ironically, it is all the people who bought because of fear of missing out on the way up that begin to panic and sell when the price drops, leading to the move down where I like to buy.
Avoid this first problem by not picking bottoms (I do sometimes pick bottoms; I was accumulating oil and gas stocks in January and February, after which oil and gas surged. But I only do that when I have solid evidence a bottom is likely to soon occur). Wait for the huge rally that is bigger than all prior rallies in the downtrend, and that is bigger than the last major down move. AND THEN, wait for the pullback.
The next problem investors face is knowing when to buy on the pullback that follows a big rally. Especially following a rally as big as this! Take the Silver Miners ETF (SIL) for example. It went from $14.94 to $54.34 in eight months. When the price starts to drop, at what point in that huge price range should you buy!?
History helps. By looking through all prior price rallies in this context, you get an idea of how far the price typically pulls back. For gold and silver stocks, the retracement is typically 45% to 55%. That doesn’t mean a 45% to 55% drop, but rather the price pulls back about 45% to 55% of the move from $14.94 to $54.35. In other words, the ETF rallied about $40, so we expect a drop of about $20 or roughly 50% of the advance. Different markets tend to pull back different amounts. That is how much gold/silver stocks tend to pullback, but oil stocks or utility stocks (or any sector) will be a bit different.
Since gold and silver stocks typically retrace about 50% of an initial rally higher, that helps you establish an entry point area. Whether you are trading the gold miner (GDX) or silver miner (SIL) ETFs, or buying individual stocks, when SIL or GDX retrace into the 45% to 60% region it is time to start accumulating in anticipation of the next rally.
Here is a look at the silver miners ETF chart.
Here is a look at the gold miners ETF chart.
Trends rarely have one move wave higher and then reverse into a downtrend. Following an up wave like this you typically have a big correction, followed by another strong wave to the upside, followed by another major correction and then another wave up.
None of this is a prediction of what will happen, it is just how the market typically moves. If this scenario plays out, the potential profits on the stocks I am buying (and I am very selective) are between 250% and 450% (conservative estimates, based on historical precedent). Compare that to the downside. Even if these stocks go to $0—which is extremely unlikely—your conservative reward potential is several times your absolutely worst case (company goes bankrupt) scenario. And I do filter through the stocks making sure I am not buying healthy ones.
There are also no guarantees the price will pullback into the buy zone. This is just what typically happens, and I would rather trade based on that evidence—which has worked repeatedly over the years—than just guess what the market is likely to do. I enter at the price I want, do I don’t enter at all.
Key Takeaways for Buying Gold and Silver Stocks
Here are your key takeaways:
- Evidence confirms an uptrend in gold and silver stocks.
- Uptrends move in waves higher, followed by corrections and then another wave higher.
- Corrections following an initial wave higher typically retrace 45% to 55% of the wave higher, history shows.
- When SIL or GDX move into this retracement area, it is a buy signal for the ETFs and for gold and silver stocks that are correlated.
- These stocks move a lot; be prepared for significant fluctuations and further drops. The price typically pulls back about 50%, but there is no reason why it can’t pull back 70% or more. I only really question the trade if the market retraces the entire advance. For investments, I may accumulate a position at several price levels.
- These stocks and ETFs will likely greatly exceed their August highs, as the next up waves unfold. The reward based on my exit point is many times my potential risk (even the worst case scenario, which is highly unlikely in the stocks I buy).
- None of this is a prediction or even opinion. Anything can happen, but this is what typically happens. And trading based on typical is about as good of an investment strategy as you can get.
Where to get out is a story for another day, but whenever I take a trade I always know my exit point. The exit is as calculated as the entry–based on tendencies we continually see in the markets.
Buying Gold and Silver Stocks – Final Word
Are you taking trades based on a calculated method which has been shown to work? If not, you are likely one of the people who buys way too early and then is forced out of the position when the big correction comes, or you wait too long and miss out completely. Know how markets move, how much they typically move, and always trade with a plan and exit in mind. As a final note, as an investor, your likely reward should always exceed even the worst case (unlikely) risk.
Cory Mitchell, CMT – Trader, investor and author of the Stock Market Swing Trading Video Course.