How to trade gold

The gold trade touches just about every part of life. From smart phones, to medical and dentistry tools, technology and space exploration, to art, jewellery, means of exchange, investment and finance. If someone mentions the term “precious metal”, gold is most likely what comes to mind.

So, what is gold exactly and why is gold so popular? At the same time, why investors love to trade gold and how to invest in it?

Since its discovery thousands of years ago in ancient Egypt (sources date gold discovery back to 2450 BC in Nubia, ancient Egypt), gold has been an object of desire. With a history literally written in the stars, since gold deposits are a result of cosmic events that happened millions of years ago, in the early days of the earth’s formation, it is not hard to see why people, the world over, are drawn to it.

Gold is a precious metal. By definition, a precious metal can be found in the earth in its natural raw state and is rare, resulting in it being highly valuable. With global gold discoveries just under 250,000 tons, lustrous gold ticks all these boxes. Its purity is measured by how many parts gold, are in a 24-karat piece. A 12-karat piece has 12 parts gold out of 24, therefore 50% gold content. An 18 karat has 18 parts gold out of 24, therefore 75% gold content. A 24 karat has 24 parts gold out of 24, therefore almost 100% purity.

Gold’s ISO code is XAU and has its root in the Latin word Aurum, which means “shining dawn”, in reference to its yellow hue (colour). In many places, the ISO XAU, along with the karat content, is stamped on jewellery and bullion bars.

When an item is able to retain the same characteristics that made it valuable centuries ago, it goes without saying that its popularity can only grow. As science and technology evolved, even more reasons emerged that supported gold’s value across multiple sectors. The four main sectors controlling gold today are jewellery (physical), investments / financials, central bank reserves and technology.

Gold is highly resistant to oxidation making it a noble metal. It manages to retain its shine, colour, quality and most importantly, its indestructability over the millennia. Yearly, 2500-3,000 tons of new gold are mined and 1,100 tons are recovered through recycling.

Gold has a relatively low melting point at 1,064 °C, that makes it malleable (hammered to a thin layer) and ductile (drawn into a wire without breaking). It is actually the most malleable and ductile metal, with silver coming in second.

At the same time, the difficult and costly process of mining gold, instils confidence to investors who trade gold that it will hold its value over the years, unlike currency that can be printed at will by central banks.

Depending on the investor’s plan, speculation and long-term investing are both viable options to trade gold. It can also be used as a tool to hedge against inflation and economic uncertainty.

As an investment vehicle, gold offers diversification in any portfolio, at any stage of the economic cycles. Where stocks and bonds fluctuate as a result of the macro environment, gold spreads the risk thin, given its positive correlation to inflation and negative correlation to its counterpart USD.

Continuing with stocks and bonds, its important to note that they cannot be offloaded as easy as gold can. Almost every neighborhood probably has a local gold buyer, who is willing to take gold off people’s hands for a price. One cannot say the same about stocks, bonds and other assets.

Gold has long been regarded as a safe haven asset and a store of value. By purchasing or choosing to trade gold today, an investor buys an asset already in value (also known as intrinsic value). Although speculation and riding the price fluctuations is an extremely popular way to trade gold, buy-and-hold transactions are prevalent, since they allow investors to take advantage of gold’s real properties as an investment.

To begin with, gold is very volatile. The smallest reason can trigger spikes or dips in gold prices, making it a sought-after speculative product. Factors that affect gold prices include:

Supply and demand
Speculators (whether companies or individuals), are in constant search for a return on the price fluctuations of gold. This in turn shifts the forces of supply and demand in either direction, and they usually follow the news relating to the underlying (even though they might be speculating without holding any gold). Overdemand tends to increase the price and oversupply does the opposite.

Inflation and interest rates
Gold has a positive correlation to inflation. During periods of overheating economies, people have money to spend and they do so. This sends prices into a heated spiral and central banks must intervene to keep them under control. A way to do this is through monetary interventions, that raise the prime rate in response to a rising inflation rate. Gold is the go-to asset to look into in such times, as it’s inflation protected and provides a cushion where most other asset classes lose.

Currency moves
Due to the fact that gold is priced against the USD, any factor relating to the USD strengthening or weakening will have an effect on XAU. By default, the correlation between the two assets is negative.

Politics/Geopolitics
In times of political uncertainty or international instability among nations, gold will always be considered a safe haven and a protection. Examples include gold prices after crisis, tensions, wars compared to the fiat currencies directly involved (look at Eurozone crisis in 2009, or the more recent Russian-Ukraine conflict).

Gold supply
Gold has a finite amount of proven reserves, as well as a specific capacity for production in any given year. This capped supply (at some point all reserves will be mined), is a driver for the price increase we have been witnessing since the beginning of the gold exchange standard in 1897, when gold had a fixed price against the USD at 20.67 USD. Prior to that, gold averaged at 20 USD per ounce.

Gold production appears to have become stagnant over the last decade. In addition to the limited production/supply, the fact that over 50% of gold is used for jewellery that doesn’t go back into circulation (it’s held for years, maybe generations), the price of gold will see further increases into the future.

Industrial demand
As technology advances, gold demand increases with it due to its applications across dental (combination with other metals to create a tooth crown and fillings), medical (arthritis, pacemakers, stents, battery casings, suture rings, all use gold plating), tech (gold wires for circuits in computer chips, semiconductors, nanoparticles), space exploration (shielding spacecrafts from infrared radiation and heat), smart phones (circuit boards) etc.

Central bank reserves
Individuals are not the only smart investors looking into gold for maintaining and storing wealth. Larger institutions like central banks eliminate counterparty risk (freezing of assets, exposure of currencies abroad), and also fine tune their wealth by maintaining and increasing their gold reserves.

With the shifting tide in geopolitics, the world gold council has surveyed the potential of increased inflows of gold as a response to crisis that could undermine the value of other assets held in reserves.

Among 70 responders, 29% intend to increase their gold reserves due to “The planned purchases are chiefly motivated by a desire to rebalance to a more preferred strategic level of gold holdings, domestic gold production, and financial market concerns including higher crisis risks and rising inflation.”

According to the World Gold Council, over 90% of global trading volume in gold, is centered in the US, the UK and China. The remaining 10% is supported by other smaller exchanges and OTC markets that include Dubai, India, Singapore, Hong Kong, Japan etc.

London OTC markets: Due to its location and its ability to connect Asian and US trading sessions, London became a hub for financial services and gold trading. According to the world gold council, approximately 70% of the global notional trading volume passes through LBMA, the Loco London Precious Metals Market. London sets the global benchmark for gold pricing twice a day also known as the LBMA Gold Price. Veterans to gold trading would recognize the reference “London Gold Fix” that was replaced by “LBMA Gold Price” in March 2015.

US futures market (COMEX): The COMEX derivatives exchange that is operated by the CME Group is next in line in terms of gold trading volume. COMEX has been gaining prominence since the 70s and focuses on futures contracts with very few physical settlements. A big contributor to its volumes, is the Asian market.

The Chinese market (SGE and SHFE): In just over 20 years, China has also claimed its stake in the international gold trading arena and now occupies the third place with the Shanghai Gold Exchange and the Shanghai Futures Exchange. Although the two exchanges are separated, they work in complimentary mode to drive China’s position as a price setter with its very own gold price benchmark.

Physical gold
It goes without saying that to take full advantage of the properties of gold as an investment, an investor must look into taking possession of it in its physical form. This can mean bullion bars and bullion coins. Its important to note that gold can get heavy in large quantities and requires special transport as well as storage i.e. vaults.

For large quantities of physical gold, special planning has to be in place for safety and storage. For smaller quantities, safe deposit boxes maintained with banks are considered the best way to safely store gold. The cost of renting the safety deposit box is offset by the potential loss of the asset at home storage (think of insurance on other assets you already pay for).

Important to consider that jewellery and artifacts made of gold, can also be considered physical investments in gold but due to markups and other costs, the resale values can be impacted.

Gold related stocks
Investors can gain exposure to the gold market, by trading shares of companies involved in prospecting, extracting, mining and refining of gold. Examples of such stocks include the Newmont (NEM) the largest gold miner by market cap, Barrick Gold corporation (GOLD) the second largest miner by market cap, Agnico Eagle Mines (AEM) that produces only in North America and Finland, B2B Gold (BTG) that produces in Africa and the Philippines and AngloGold Ashanti (AU) with mines across Africa, Australia and Latin America.

Stock related to gold has a positive correlation to gold prices, since with a rise of the price of gold, the assets of these companies rise in value as well. Almost all stocks related to gold have potential for dividend yield. Important to note that a company’s stock performance is not singularly affected by its assets, but there are many reasons that could impact the overall performance.

Gold related ETFs and funds
Funds that track the price of gold or hold physical gold or include gold related stocks, are another way to gain exposure to the lustrous asset. Gold ETFs in particular, offer liquidity and transparency for the underlying gold assets. All the ETF product advantages are applicable (highly liquid, diversification through a basket of securities and the upside potential).

ETFs require minimum level of diversification, so if investors want to invest in a fund that tracks a single commodity, they would look into ETCs or Exchange Traded Commodities, which are gaining momentum in Europe.

Examples of ETF products related to gold are SPDR Gold Shares (GLD) with over $64b in AUM. It listed in NYSE in 2004 and is the largest physically backed gold ETF. iShares Gold Trust (IAU) is another example with total AUM at over 29b USD. IAU holds over 378 tons as of July 2024. Other examples of funds invested in gold include Fidelity Select Gold Portfolio (FSAGX), First Eagle Gold Fund (SGGDX), Invesco Gold and Special Minerals FD (OPGSX) and VanEck International Investors Gold Fund (INIVX).

Gold-backed crypto

Part of the stablecoin family, gold-backed crypto are cryptocurrencies that are backed by a commodity, in this case gold.

Physical amounts of the commodity are kept in reserves equivalent with the circulating supply of the coin/token. These digital assets are becoming more appealing to traders and investors to protect their portfolios the same way real gold trading would.

Examples include Tether Gold (XAUt), Digix Global DGX , Paxos Gold (PAXG), AurusGOLD (AWG).

Gold derivatives (futures, options and CFDs)

Derivative products are those that offer exposure to assets without physically holding the underlying. These are contracts with a predetermined expiry, and depending on the type, they can give rights or obligations to be fulfilled.

These contracts have standardized sizes and use leverage to amplify potential upside. However, as amplified as the potential upside is, so is the potential downside. Derivatives are considered complex instruments that require experience and diligent management to handle.

Due to this amplification, liquidation is a real possibility and special attention should be placed on the logistics of the trades i.e. margins, margin calls, stop-outs, and leverage controls.

Margin: To trade gold through derivatives, a transaction involves a collateral locked with a broker called margin. Margin requirements vary per broker, depending on their status of regulation (if regulated or not), and of course where they are regulated. These requirements are defined in the Key Information Document (KID) which a trader should go through and understand.

Margin call: Traders are notified that their account is reaching critical levels by what is known as a margin call. This is a very important tool that supports the risk management function we will explain later. If a margin call is triggered, traders must take immediate actions by either liquidating some positions to free funds and meet margin requirements, or deposit more funds into the account.

When investors trade gold through derivatives, they must be aware of the substantial risk of loss involved. To mitigate this risk, there are various tools and strategies that can be deployed by a gold trader. Everything described above, as well as what will follow aim to map out the environment and its elements which is the first step in minimizing any risk. Know your environment.

The next most important factor when learning how to trade gold is to utilize all the tools and techniques surrounding the actual trades, that will help traders manage their risk. Such tools include stop-loss and take-profit limits.

Stop loss: a limit a trader places on a position, that instructs the system to close the trade automatically in a loss. This is a predefined level, calculated by investors who trade gold before-hand, and acknowledges the acceptable loss, should the market moves in the opposite direction.

Trailing stop: A variation of the stop-loss is the trailing stop, predefined at a percentage level below the current price. As the market moves, the trailing stop moves as well. Should the market move in the opposite direction, the position closes at the trailing stop. Should the position move in the correct direction, trailing stop continues to trace the price at the predefined percentage. In this case, the trailing stop, becomes a take profit since it can lock-in an amount of profit from the positive move.

Take-profit: a limit placed on the position that instructs the system to close the trade automatically in a profit. This is also predefined by gold traders and locks-in the desired profit.

Pending orders: There are 4 types of pending orders, that are queued in the system and only execute when specific conditions are met. These are buy/sell limit orders, and buy/sell stop orders.

• Buy/sell limit orders expect the price to change directions.
• Buy/sell stop orders expect the price to continue in the same direction.

Key takeaways of chapter 10

• Identify the trader type
• Apply risk management based on risk tolerance
• Analyze gold through technical and fundamental analysis
• Decide if its a good time to trade gold. If not, consider waiting or place limit orders according to the analysis
• Pick the size and direction of the trade
• Test the strategy on a demo account

Identify the trader type

The Day Trader – Trades intraday. Positions are opened and closed within a day’s session and no positions are to be left open overnight.

The Swing Trader – Trades over a few days or weeks. The goal is short-to-medium term gains by taking advantage of swings and ranges (usually between support and resistance levels). Technical analysis might not be enough, so a broader fundamental outlook is required for the bigger picture.

The Technical Trader – trades based on technical analysis of price charts. Extensive use of chart patterns like head and shoulders, ascending/ descending triangles, as well as technical indicators from hundreds available to define a strategy.

The Fundamental Trader – Long term trading associated with buy and hold rather than short term profit from multiple transactions. A broader look into the economy or a company’s fundamentals in the case of stock trading. The aim is to quantify and qualify through financial ratios and economic indicators.

The Long Term trader (or position investor) can place trades that last from a few weeks to many years (think Warren Buffet). They hold onto a position over an extended period of time after identifying a trend that will take a while to materialize into profits.

If we were to become very specific, we could identify other categories like fixed income traders, arbitrageurs, scalpers, momentum traders, price action traders, contrarians, algorithmic traders, and the list goes on.

Apply risk management based on risk tolerance

Scalpers and day traders have a higher threshold for risk. They open multiple transactions and they do it using techniques that allow them to do so with small margin requirements. Long term investors usually have lower risk tolerance and apply different techniques to support their transactions.

Understanding and applying these techniques ensures that there are no surprises if the market moves in either direction. Any potential loss or profit is predefined by the calculated levels.

Analyze gold through technical and fundamental analysis.

This applies mostly for beginners. Not all markets need to be traded from the beginning. Analysis can be fundamental, technical, historical, ready made from analysts of a broker or external.

Fundamental analysis is the study of important financial and economic indicators. Depending on what is being studied, it can relate to a macro environment (economy) or a micro environment (company level). Fundamental analysis for gold trading, studies the macro environment unlike stock trading that studies both macro and micro. The goal of fundamental analysis is to find the real value of a security that will be derived from its sale on a future date.

Technical analysis is the study of charts (visual representations of price moves) through mathematical formulas known as technical indicators. Analysts in this category believe that the markets already took into consideration the fundamental aspects (markets discounted everything), and predicting the future is all about identifying the trend, the momentum strength, the volatility and the volume of transactions at a specified period.

Decide if its a good time to trade gold. If not, consider waiting or place limit orders according to the analysis

The decision must be based within an educated context. Ready made analysis usually includes target levels, known as support and resistance levels.

Pick the size and direction of the trade

Whether the analysis was manually crafted, or conducted with the help of ready-made tools, the direction can either be long or short (or both in some strategies and if the broker allows).

Test the strategy on a demo account

There is no need for a beginner trader to ride a live account immediately. Strategies can be tested on virtual accounts, also known as demo accounts using virtual money. Demo accounts allow gold traders to test the execution of brokers, the speed, the accuracy and the service. Bear in mind that they don’t always reflect exactly the live trading accounts. Demo accounts can be used in tandem with live accounts, or as stand-alone back testers. Irrespective of how they are used, they must always be part of the overall experience. They are free, so why not?

Selecting a broker might be the hardest task of all. A gold trader can choose the same broker used for the demo or another. There are thousands of brokers, so if gold traders followed all of the above chapters correctly, they will know which broker is the most suitable to their needs.

Open an account and follow the KYC requirements

Depending on the broker, Know Your Client (KYC) procedures can be extremely easy or extremely difficult. Choosing a heavily regulated broker, toughens their acceptance policy, requiring gold traders to supply added documentation. This can mean regular documentation might not be enough, maybe notarization of certain documents, maybe apostilled documents and even original documents in some cases. Lighter regulation (or no regulation) means looser acceptance policies but a riskier trading environment relative to funds and trading.

Fund your Real account

• Deploy the trading plan already in place.
• Open a transaction using the trading platform’s options and features. The most well-known platform in the market today is Metatrader from Metaquotes. Their latest version is MT5 but older versions of MT4 are still available to traditional traders.
• Monitor the transaction through the trading platform.

Close the transaction when ready to exit
Closing a transaction in a loss might be more profitable than leaving it open and risking further losses. This is why most traders prefer to automate the transaction closing, through the risk management tools mentioned above.

Part of the trading platforms is the journal or trading log. These allow gold traders to review their results at will and help them improve their skills. Many times, skills might not be enough to sustain a profitable account. Psychology plays a large role in how gold traders react to negative and./or positive live moves and the better they know themselves, the more resilient they become over the course of their trading careers.

Socializing with other traders and groups is very important since the shared knowledge and experience can go a long way. Whether through trading mentors, forums, blogs, social media platforms, trading academies, there are always ways to interact and discuss ideas and strategies. Evolving through these processes and exploring tools, technology, new strategies, automation and copy trading can make the all the difference while learning how to trade gold through derivative products.