Be wary of how you use correlation as a trader. Precious metals are a good example of this. I often hear people say that movements in precious metals are correlated. It’s true, there is a positive correlation between them but it’s not 100% and it often changes. That means you can’t be sure they will move by the same amount or even in the same direction in the short term.
There are traders that wait for Gold, Silver or Platinum to move, then jump on the lagging metal hoping to ride it to a gain. Now while this may happen in some instances, in my view this trading scenario depends far too much on luck.
I believe that as traders we need to focus our effort. Markets move up and down, and as traders we need to have a strategy that is based around the market we are trading. So, if I am going to trade Gold, I will only be looking at the Gold chart. The same goes for Silver, or Platinum.
Gold is without doubt the most commonly traded metal. I’m going to begin by focusing on the daily Gold chart as I believe it provides a wide enough view to effectively deconstruct the correlation myth.
Here is the Gold chart.
And here is a chart of Silver to compare.
As you can see, these two charts are not exactly correlated. There is no doubt they have by and large moved lower together on the major trend down. But they have not, by any stretch, each moved to the same extent. In fact, the last week or so has seen Silver make gains, while Gold has continued lower. What are the implications of this for someone who has bought gold hoping it would follow silver higher? It simply means that they will either have lost money or will still be sitting in Gold hoping for it to move higher like Silver. A very possible outcome is that they would have lost.
What about Platinum? Well here is a chart of Platinum.
In this case, it looks rather more as if Platinum and Silver are moving together. Platinum has seen a little move higher - less than Silver, but it has moved higher. So there has been some correlation there. But the key issue here is that on the days Silver has moved higher, so has Platinum. Which means the trade lag approach would not work here either.
I can hear some of the correlation lag traders screaming at the screen now, saying “get long Gold, it’s so obvious.” And for a trader looking to trade this correlation lag, that would seem to make sense as it’s the lagger in this scenario. The issue I have is that I often see Gold as the leader, so in my view we are likely to see Silver and Platinum falling before Gold rises.
Gold may eventually rise on this occasion. However, my main point is that markets are driven by their own specific influences and do not always move together. I like to keep my strategy based around the market I’m trading. If that is Gold, then I will only be looking at the Gold chart, and the same goes for Silver or Platinum. It’s easy to justify a trade to yourself, but that doesn’t necessarily make it a good trade. I like to be focused on the market I am trading, and not the other markets around it .