During furious bull and bear markets one of the main questions is when to get long / short these markets. In other words, taking a precious metals market as an example, during its bull market phase investors want to get involved by buying specific stocks. It means that in most cases they are wildly chasing the best / worst performing stocks without any plan. In my opinion, it is a good recipe to become frustrated or disappointed. And a frustrated / disappointed investor makes mistakes.
In this article I want to present a simple method to get along with these problems using an investor-friendly approach.
Relative strength measures how a specific stock performs against another stock, asset class, commodity etc. When somebody says that the stock A performs better than the stock B it means that the stock A is relatively stronger than the stock B. Let me show an example.
The graph below shows the relative strength of GDX (a popular ETF tracking gold-related stocks price action) against gold:
It is easy to spot that between April 2011 and January 2016 GDX prices were going down faster than the prices of gold (red line going down, painted in the yellow area on the lower panel of the chart). However, in January 2016 GDX prices started going up faster than the prices of gold (green area). I think there is no need to say that since the beginning of this year we are in the bull market in gold and gold-related stocks.
Using different wording - one may say that since the beginning of this year GDX has been relatively stronger than gold, which is indicative of the ongoing bull market in gold-related stocks.
How to calculate the relative strength of the asset A against the asset B? To do it, one has to divide the prices of the asset A by the prices of the asset B over the chosen period.
How to use relative strength to find the best entry points?
In my opinion, relative strength allows to identify the well-timed and credible points to go long specific shares during the ongoing bull market in gold-related stocks. To use it efficiently the following recipe is recommended:
- Do not chase any stock
- Use relative strength to measure the stock performance against the broad stock market (for example, in gold-related stocks use GDX or GDXJ as a broad stock market measure)
- When your stock is underperforming against the broad stock market - look for entry points (this is your opportunity)
B2 Gold entry points
In my opinion, B2 Gold is one of the best miners in the entire industry. The company currently runs four mines but in late 2017 it plans to open another high-profile mine, Fekola in Mali (for those interested in my report on the company - the link is here).
Apart from being a decent miner, the company's shares are held by one of the most popular gold-related ETFs (NYSEARCA:GDXJ), which results in additional, higher demand on these shares. Due to these facts, BTG shares are being chased by many investors and GDXJ managers so setting the right entry points is a vital issue in trading them.
The chart below shows a few model entry points for B2 Gold bulls, using the relative strength between B2 Gold shares and GDX:
How to read this chart?
Firstly, note that till late January 2016 B2 Gold shares were relatively weaker than GDX. Then, around January 25, 2016 a furious bull market in BTG shares had started (green, vertical line on the lower panel of the chart). Since that time the company's shares have gone up by around 140%. What is more, as the upper panel of the chart shows, there were only a few periods when this furious bull market in B2 Gold stocks slowed down a little bit. Those periods (marked by figures "1" and "2") may be easily identified on the lower panel of the chart, showing the declining relative strength of B2 Gold against GDX.
For example, the period "1" (between February 22 and the beginning of March) indicates the first opportunity to buy B2 Gold shares (letter "a" on the upper panel). During that period the relative strength of B2 Gold against GDX was going down; this phenomenon was accompanied by BTG shares trading for a few days at around $18 a piece - then they continued their march up.
The second period ("2") was much longer. Between the end of March and the beginning of June the company's shares were once again weaker than GDX.
However, during this underperformance I identified at least three good entry points to go long B2 Gold (letters: "b", "c" and "d" on the upper panel of the chart).
Now, let me take Newmarket Gold. This company is another example of a decent and prospective miner (those interested in more details on the company's fundamentals - check this link).
Most recently a notable Canadian investor, Eric Sprott, has acquired large stakes in the company (currently Mr. Sprott holds a 17.5% stake in the company). This event aroused the interest of other investors and Newmarket Gold shares entered a strong bull market.
The chart below shows the best entry points to go long Newmarket Gold shares:
The bull market in Newmarket Gold shares started in middle February 2016 (green, vertical line on the lower panel of the chart). Since that time there were two periods when the company's shares were relatively weaker than GDX shares.
The first period (marked by the figure "1") allowed to identify an entry point ("a") as a good opportunity to go long these stocks.
Since the point "a" Newmarket Gold shares went around 70% up. Then, after hitting their record high in middle May, the company's shares have been trading between $2.7 and $3.0 a share. In my opinion, current prices may be regarded as a good opportunity to go long these stocks (points "b" and "c"). Now Newmarket shares are trading in a relatively narrow price range but their relative strength against GDX is going down. To be honest, due to the fact that the relative strength is still going down, patient investors may identify even a better (lower) entry point.
I believe that relative strength is one of the simplest, clear and logical methods to find entry points to go long stocks during a furious bull markets. The best feature of this method is that it neutralizes the emotional factor of the investor's mind (and I am sure that it is common knowledge that the investor's mind is the biggest investor's enemy). In a disciplined and simple way investors may identify good entry points to go long stocks without chasing them senselessly.
Disclosure: I am/we are long GDXJ, BTG, NMKTF.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.