Doji Candlestick Points to Upside for Silver

by Tyler Craig | November 1, 2012 12:06 pm

After falling four consecutive weeks, the iShares Silver Trust (NYSE:SLV[1]) appears poised to resume its intermediate uptrend. Recently, gold’s high-beta cousin formed a classic doji candlestick pattern on its weekly chart. For those unfamiliar with candlestick lore, here are a few key characteristics of the doji:

  1.  A doji candle looks like a cross and forms when the open and close of a trading session occur at or near the same price level.
  2. If we consider each trading session a battle between the bulls and the bears, a doji forms when the contest yields a stalemate where neither army gains the upper hand.
  3. When the doji forms after a multi-candle move in one direction, it acts as a potential reversal signal.

Because last week’s doji candle came on the heels of three weeks of selling, it suggests bearish forces are losing momentum and are vulnerable to a bullish counterattack. A break above the high of last week’s doji candle ($31.44) would act as confirmation of the bullish reversal.

SLV -- Weekly
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Dojis have been particularly potent in SLV: They have occurred near some key reversals over the past few years. Two prior examples along with last week’s development are circled in the chart at right.

While silver has been under pressure throughout the recent market correction, silver mining stocks — as measured by the Global X Silver Miners ETF (NYSE:SIL[2]) — have experienced notable relative strength. Historically, silver and silver mining stocks exhibit a strong positive correlation. Like best friends, they tend to mimic each other’s behavior.

The indicator we chartists use to measure how related two securities are is known as the correlation coefficient, or simply correlation. It ranges between -1 and +1; readings close to +1 reveal a strong positive correlation and readings close to -1 reveal a strong negative correlation. When two securities exhibit a strong positive correlation, like silver and silver miners, it simply means they move in the same direction.

SLV -- Correlation With SIL
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The correlation of SIL and SLV has remained close to +1 throughout the past six months. In recent weeks we’ve seen the correlation dip just a bit as silver miners have continued higher while silver has been selling off. If history is any indication, we should see the correlation revert back toward +1 as silver miners and silver begin moving together once again.

If the recent doji in SLV is any indication, it appears the disparity in the recent movements of these two securities should resolve itself, with silver rising to play catch-up to silver mining stocks.

One play worth consideration to exploit neutral to bullish behavior in SLV is selling out-of-the-money December 30 puts for around $0.65 or better. Consider it a bet that SLV will sit above $30 by December expiration. The max reward is limited to the initial $0.65 received at trade entry. To minimize the risk, consider closing the position if SLV breaks below $29.50.

At the time of this writing, Tyler Craig had no positions on any of the aforementioned securities. 

  1. SLV:
  2. SIL:

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