Gold, Stocks: Tough Markets to Trade Now

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( Options Trading Signals) -- A lot of eyes were watching the Slovakian Parliament around the closing bell Tuesday as it voted on the European Financial Stability Fund (EFSF).

Legislation approving the enhanced bailout fund failed to pass on a first vote, but members of the opposition party have indicated that they will vote for the bill in a second vote.

The trapdoor risk for equity traders is that the second vote comes up short. The market is expecting the second vote to pass without issue, but if it doesn't, selling pressure could become extreme. This just adds more headline risk when the market already had plenty because of earnings season.

We have seen the S&P 500 Index rally more than 10% in five trading sessions. That means the market may have to see more declines before it can probe higher.

The flip side of that argument is that prices continue to rally and push toward key resistance levels.

Right now, I do not have an edge for a directional trade, so I am sitting on the sidelines. I do have a few time-decay-based trades in place, but they do not have a directional bias. Thus, my book is flat.

The S&P 500 is a tough buy after a 10% rally in such a short period of time, but the strength and momentum are tough to short. The buyers seem to be higher and the sellers appear to be lower, which further complicates a potential entry. Presently there appears to be two possible scenarios:

Bullish Scenario

The daily chart of the S&P 500 index is shown below with key overhead resistance levels illustrated on the chart and the potential price action in coming days:

Bearish Scenario

The daily chart of the S&P 500 index is shown below with key support levels and the potential price action if prices work lower:

Overall, I do not have a real edge on the S&P 500 at this point. A pullback makes some sense here, but defined risk metrics and a trading plan must be used to reduce risk. Regardless of the price direction traders are considering, this is a situation where proper position sizing and stop orders can allow a trader to take on a defined risk that he/she is comfortable with.

This market has been a tough to trade for several weeks. The price action has been choppy, and volatility levels have been elevated since early August. This type of market environment chops up a lot of traders, and it sucks bulls and bears into the price action late in the game, opening the door for potentially devastating losses if risk is not properly defined. My trading partner Chris Vermeulen pocketed more than 38% gain during these choppy times using bull and bear ETFs.

As an options trader familiar with a variety of spreads, recently I have been utilizing the elevated volatility levels to sell option premium and use the passage of time as a primary profit engine for my open positions. Currently I have three open positions, all of which take advantage of the passage of time as a profit engine.

Back on Sept. 26, I entered a $DIA Iron Condor Spread to take advantage of heightened volatility and capitalize on time decay leading up to the October monthly option expiration. On Oct. 6 I was able to close the $DIA position to lock in 15% based on maximum risk. Even though price action was excessively volatile during the past several weeks, my $DIA trade was never a major concern in terms of price action. No adjustments were necessary, and I pocketed some relatively quick money watching the days pass by.

Gold Analysis

The recent price action in gold has been as tough to trade as the S&P 500's. After rallying sharply into early September, gold prices plummeted and price action has been consolidating ever since. Gold prices have just chopped around for several weeks, and the metal is currently trading in a bear flag formation that if triggered could result in additional downside.

In the short term, more downside is always possible, but in the longer term I think higher prices are probable for both gold and silver as this money-printing binge will one day end and inflationary pressures may present themselves at that time. The weekly chart of gold futures is shown below:

As can be seen above, gold has traded in a long-term rising channel for over a year. Back in August and September gold prices broke out to the upside of the rising channel and went parabolic. In the beginning of September, gold prices sold off sharply back down into the previous rising channel. As it stands right now, gold prices remain near the upper resistance level of that channel and have not tested the lower support line since February.

If gold prices do begin to roll over in the days and weeks ahead, a logical entry point would be a test of the lower channel. The price level I would be watching for would be around $1,500 an ounce. If we get to that area, I would not be shocked to see an overthrow of that support level and a test of the $1,480 price level before reversing to the upside.

The other side of this story is that the U.S. Dollar Index falls out of favor again and its price gets crushed. If the dollar gets hammered lower, it would make sense that U.S. domestic equities would rally along with other risk assets such as gold, silver, and oil. Right now I do not have a clear short-term bias, but in the intermediate- to longer-term cycles I remain quite bullish. If the gold price does work back down to that support level, I will be looking to get long. Another possible long entry would present itself on a breakout to the upside back out of the upward sloping channel.

Gold is quite volatile and is impacted by a litany of outside forces such as foreign currency and the dollar. For now the short-term bias could be to the downside, but when this period of malaise in the yellow metal ends the next bullish phase of this move higher is going to be quite strong.

As I have said many times, sometimes the best trade is no trade at all. Right now I do not have an edge in either the S&P 500 or gold so I am just going to sit and watch price action patiently while looking for high-probability, low-risk setups to emerge.

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