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Technical Tuesday - When to Buy Silver Again

By Chris Rowe May 3, 2011 Facebook Logo Twitter Logo Email Logo LinkedIn Logo

Last week we discussed the recent top in silver at about $50.00, and whether or not the silver bull is dead.  We concluded that, given the strength silver has shown us in 2011, silver will likely see continued strength and upside, but only after the recent massive gains are digested (in the form of consolidation). 

First let me clear up some confusion. 

Last week I told you non-futures traders can gain exposure to silver through the iShares ETF (Symbols SLV).  But the charts I used were charts on the actual metal itself, not the ETF that tracks the price of silver.  Some readers said the charts didn't match what they were seeing in SLV, and that's because the silver chart is the slightest bit different than the SLV chart.

Let's talk about the recent decline in silver, and about the best way to enter the metal. 

Silver recently sold off by about 15% from the high, and it seems like the main culprit was the main U.S. metals exchange, the CME Group, who raised margin requirements three times in just over a week! 

Some brokerage firms even raised the margin requirement to twice as much as the CME requirement. 

Impact?  POSITIVE!!

This has sent silver down to about $43.00, as the highly leveraged speculators are being forced to exit their positions that they can no longer maintain.  Great!  WASH 'EM OUT before it gets too out of hand! 

If you're a silver bull, you really don't want many highly leveraged speculators trading alongside of you, even though it might push prices up fast.


First, consider why this is happening.  Basically, if you max out your borrowing ability and your broker calls or emails you, telling you that you have to pony up more money to maintain the position, you are forced to sell either the entire position or just enough to get you the required capital to maintain a position. 

Think about the people that are getting shaken out of the trade.  It's the over-leveraged speculators.  The big risk takers.  The irrational people.

We call it "hot money" that's forced out of this market.  And that's a good thing for the bull market in silver, because those "hot money" traders would have just continued to put any profits they made right back into silver, pyramid style, so that they are, once again, leveraged to the hilt.  

It's the same concept as the real estate speculator who used any increase in value of a home they bought to refinance that home, pull the profit out of the home, leaving minimal equity and buying another home.  Before he knows it, the speculator owns 5 homes with the minimum equity cushion and, as long as the market pushes higher, it's all cookies and cream!  

But unlike the real estate market, in the futures market, you can't keep the investment if it looks like you're at risk of going "underwater".  You get sold out of your position in the blink of an eye by your broker, or else the brokerage firm that handles your account will be the one eating the loss on your position.

When speculators are allowed to leverage themselves to the hilt, it creates a bubble that can send prices down 25% in a flash when they are forced out by market prices.  So the fact that the CME Group and the brokerage houses are getting in front of this helps avoid the ultra sharp sell-offs that would have inevitably occurred.  And that's why this is a positive for bulls.

What we don't need is a security that can be up 20% one day and down 25% the next.  What we don't need is tons of forced liquidation.  Why?  Because it becomes easier to lose money, or to trade on false signals.  It's easier to get whipped out of a market that's so volatile.

We want something that's going to trade up steadily, so that the sell signals are clear and easy to trade. 

So THANK YOU brokerage houses and CME for raising the margin requirements.  You've just done Tycoon Report readers a big favor!

Avoid Common Mistakes

The common mistake in a situation like this is for the buyer to be more concerned about missing the next advance than they are about taking a loss.  They jump in too quickly before seeing any confirmation that demand is back in control.  Sound familiar?

Don't be that person! 

Don't try to turn this into what you want it to be.  I know it sounds crazy, but many traders do this.  If you look at the chart of silver below, you can see it jumped about 50% from September to the early November peak.    After such a huge run in just over 2 months, investors wanted to take part in the next big move, so they jumped in between $28 and $25.00. 

Although the metal did advance in price from about $25 - $31.00 (24%), hardly anyone actually bought it at the low of $25.00 and traded it to $31.00 and sold.  While most investors were hoping to see another 50%+, what happened was we saw 2 months of consolidation before silver really launched another massive run higher.  By late January, silver was at about the same price it was at in November.

(Click on image to enlarge)

Typically, the larger the upwards move is, the longer the consolidation period is.  We just saw a move of 85% from the January low to the recent high. 

Also, if you look at the indicator below the price chart, the commitment of traders, you can see that the "Large Traders" (the guys who are usually right) have been piling out of silver.  If you look at what happened in the past, the beginning of the large moves usually started with that red line moving up, indicating large traders had increased their buying.  Waiting for that to occur may be the best time to enter an intermediate-term (weeks to months) position. 

Last week, based on the recent uptrend line and return line, I told you that strong stomach traders had a low risk-reward ratio, because if it moved below the return line it was a sell.  That occurred. 

Silver as of 1-week ago - Tuesday, April 25, 2011

I also said that "the next support level is the main up trend line, which would be around $40.00 - $41.00".  I still feel that's the case.  But don't think about this in a vacuum.  There are other forces at work.

The U.S. dollar, which has an inverse relationship with silver, has been tanking.  But what happens if it reverses higher?  Lots of short positions will have to be covered, which would cause a short-squeeze, a rally in the dollar, and a sell-off in commodities.  Keep that in mind as you consider entering silver. 

(Click on image to enlarge)

It might make sense to own a little bit of gold and a little bit of silver just as a hedge against an all out currency collapse or disaster.  But the significant sized trading positions should not be taken yet in my opinion. 

I'll keep you posted from time to time on the technical picture of silver.  But remember that if you see it moving higher, it doesn't necessarily mean you're missing the move.  Look at what happened from November to January to understand what's more likely to happen next.  There is probably going to be some consolidation, and we may even see more raised margin requirements.   

Don't chase silver higher, and don't trade in the rear view mirror.  Wait for some consolidation and a buy signal to occur, even if it means waiting months for the trade.