Best Strategies to Trade the Gold-Silver Ratio

Trading the Gold Silver ratio can provide traders with plenty of opportunities for profits. In this article, we’ll go over the fundamentals of trading the Gold-Silver ratio.
Best Strategies to Trade the Gold-Silver Ratio

Gold prices and silver prices generally trade in tandem. Their price movements are correlated with one another most of the time, but on occasion, the relationship breaks down providing an opportunity to trade these commodities. One of the best trading strategies is a long-short or pair trading technique where you purchase on asset and simultaneously sell the other. The goal is to generate returns from the outperformance of gold relative silver or vice versa.

When Does the Relationship Break Down?

Both gold and silver prices are inversely correlated to the value of the US dollar most of the time. Since both commodities are priced in dollar, a stronger dollar makes each less attractive to investors who have a base currency that is not the US dollar. Gold is viewed by many as a currency in its own, and during periods when there is a geopolitical unrest, traders flock to the yellow metal for protection.

Silver has many industrial uses. It is used to generate photovoltaic slides which create solar power. In addition, silver is used for electrical applications. It is also useful in medicine and consumer products. Both metals are considered a hedge against rising inflation expectations. Silver generally outperforms gold during periods when there is rising inflation as well as robust economic growth. You can trade spot metal and CFDs as well as track precious metal prices on Alpari.

Using a Mean Reversion Trading Strategy

One of the most productive pair trading strategies is a mean reversion trading strategy. This type of strategy is based on the notion that gold and silver are correlated with one another and their movements occasionally break down. The goal of the strategy is to track the changes in prices and when the movements break out to the edges of the historical range, you would purchase gold (or silver) and sell silver (or gold).

Using Bollinger Bands for Mean Reversion

The most efficient technical indicator for this strategy is Bollinger bands. Bollinger bands were introduced by John Bollinger and are generally a staple in technical analysis education and can be found as part of most technical analysis toolkits.

Bollinger bands calculate a moving average of the asset that it is evaluating. In this case, it would be the ratio of gold prices divided by silver prices (although you could also divide silver prices by gold prices). The default moving average that was introduced with John Bollinger’s initial findings was the 20-day moving average. When you are attempting to find a technical strategy using Bollinger bands, you should feel free to try many different moving averages.

To capture most of the prices or ratios during the past 20-days, Bollinger uses a 2-standard deviation range around the 20-day moving average. Two standard deviations capture approximately 95% of all the prices within the 20-day range.  If you want to capture a larger range, you can handle this in several ways – you can increase the number of days to a larger number or increase the standard deviation or alternatively, you can decrease the range you capture by reducing the number of days or the standard deviation. You can also change the periods used in the calculation by increasing it from daily to weekly which will provide you with a broader picture of the ratio of gold to silver, or you could reduce it from daily to hourly which focuses in on the most immediate price action. You can also use a view of all-three which can help you see a long-term trend and a short-term range.

The chart of the ratio of gold prices divided by silver shows that prices fluctuate in a range. The Bollinger bands encapsulate most of the 20-day period. When the ratio of gold to silver touches the Bollinger band low, you purchase gold and sell silver. When the ratio of gold to silver touches the Bollinger band high, you sell gold and purchase silver. You can take profits when the price moves to the other end of the range or back to the moving average.

You can also add in an oscillator like the fast stochastic to help you determine if the ratio is over-extended. The fast stochastic is a momentum oscillator that measures accelerating and decelerating momentum as well as sentiment. When the fast stochastic reaches a reading above 80, the sentiment is too high, and the ratio is overbought. When the fast-stochastic hits a reading of 20, the sentiment is too low, and the ratio is considered oversold. You can use the fast stochastic as a stand-alone indicator to trade the gold versus silver ratio, or you can use it in conjunction with the Bollinger bands.

For example, you can look for a period when the ratio is above the Bollinger band high, and the fast stochastic is overbought. You might even want to wait until the fast-stochastic declines back below the oversold trigger level of 80, and then place your trade.

Gold Silver Ratio

If you want to evaluate a longer period, you can also look at a weekly ratio and use this as your trigger or your guide. The trigger would work like the daily trigger (selling the ratio above the Bollinger band high and buying the ratio below the Bollinger band low). If you want to see the broader trend the weekly is a broader view than the daily. You might consider only using the daily trigger (the ratio is either above the Bollinger high or below the Bollinger low) when the weekly ratio is overextended.

Risk Management

Lastly, its imperative that you use a sound risk management strategy. A situation can occur when the ratio trends, and you want to make sure you do not decide that you are going to wait it out. Determine in advance how much you will risk on every trade and use that figure to stop yourself out of a position. The use of Bollinger bands and the Fast Stochastic as tools to determine if the ratio of gold to silver is overextended can help you generate a robust trading strategy that will have consistent returns.

In Conclusion

The Gold-Silver ratio can be used as an effective trading tool as it provides opportunities to trade each commodity separately as well as the gold-silver ratio itself. Practice the gold-silver ratio as a sentiment tool can help traders to feel the market and take advantage of irregular changes in prices. It is also important to find a broker that can provide you with fast execution and low spreads to apply the Gold-Silver strategies.

Don't miss a thing!

Discover what's moving the markets. Sign up for a daily update delivered to your inbox

Latest Articles

See All

Expand Your Knowledge

See All

Top Promotions

Top Brokers

IMPORTANT DISCLAIMERS
The content provided on the website includes general news and publications, our personal analysis and opinions, and contents provided by third parties, which are intended for educational and research purposes only. It does not constitute, and should not be read as, any recommendation or advice to take any action whatsoever, including to make any investment or buy any product. When making any financial decision, you should perform your own due diligence checks, apply your own discretion and consult your competent advisors. The content of the website is not personally directed to you, and we does not take into account your financial situation or needs.The information contained in this website is not necessarily provided in real-time nor is it necessarily accurate. Prices provided herein may be provided by market makers and not by exchanges.Any trading or other financial decision you make shall be at your full responsibility, and you must not rely on any information provided through the website. FX Empire does not provide any warranty regarding any of the information contained in the website, and shall bear no responsibility for any trading losses you might incur as a result of using any information contained in the website.The website may include advertisements and other promotional contents, and FX Empire may receive compensation from third parties in connection with the content. FX Empire does not endorse any third party or recommends using any third party's services, and does not assume responsibility for your use of any such third party's website or services.FX Empire and its employees, officers, subsidiaries and associates, are not liable nor shall they be held liable for any loss or damage resulting from your use of the website or reliance on the information provided on this website.
RISK DISCLAIMER
This website includes information about cryptocurrencies, contracts for difference (CFDs) and other financial instruments, and about brokers, exchanges and other entities trading in such instruments. Both cryptocurrencies and CFDs are complex instruments and come with a high risk of losing money. You should carefully consider whether you understand how these instruments work and whether you can afford to take the high risk of losing your money.FX Empire encourages you to perform your own research before making any investment decision, and to avoid investing in any financial instrument which you do not fully understand how it works and what are the risks involved.
FOLLOW US