How to Trade the Gold Silver Ratio ?

[niloufar mohamadi]

How to Trade the Gold Silver Ratio ?

[Sergey Golubev]

Forum

Something Interesting in Financial Video July 2013

newdigital, 2013.07.13 19:50

Trading the Gold Silver Ratio :

For the hard-asset enthusiast, the gold-silver ratio is part of common parlance, but for the average investor, this arcane metric is anything but well-known. This is unfortunate because there's great profit potential using a number of well-established strategies that rely on this ratio.

In a nutshell, the gold-silver ratio represents the number of silver ounces it takes to buy a single ounce of gold. It sounds simple, but this ratio is more useful than you might think. Read on to find out how you can benefit from this ratio.

How the Ratio Works

When gold trades at $500 per ounce and silver at $5, traders refer to a gold-silver ratio of 100. Today the ratio floats, as gold and silver are valued daily by market forces, but this wasn't always the case. The ratio has been permanently set at different times in history - and in different places - by governments seeking monetary stability.

Here's a thumbnail overview of that history:

• 2007 – For the year, the gold-silver ratio averaged 51.
• 1991 – When silver hit its lows, the ratio peaked at 100.
• 1980 – At the time of the last great surge in gold and silver, the ratio stood at 17.
• End of 19th Century – The nearly universal, fixed ratio of 15 came to a close with the end of the bi-metallism era.
• Roman Empire – The ratio was set at 12.
• 323 B.C. – The ratio stood at 12.5 upon the death of Alexander the Great.

These days, gold and silver trade more or less in sync, but there are periods when the ratio drops or rises to levels that could be considered statistically "extreme." These "extreme" levels create trading opportunities.

How to Trade the Gold-Silver Ratio

First off, trading the gold-silver ratio is an activity primarily undertaken by hard-asset enthusiasts like "gold bugs". Why? Because the trade is predicated on accumulating greater quantities of the metal and not on increasing dollar-value profits. Sound confusing? Let's look at an example.

The essence of trading the gold-silver ratio is to switch holdings when the ratio swings to historically determined "extremes." So, as an example:

1. When a trader possesses one ounce of gold, and the ratio rises to an unprecedented 100, the trader would then sell his or her single gold ounce for 100 ounces of silver.
2. When the ratio then contracted to an opposite historical "extreme" of, say, 50, the trader would then sell his or her 100 ounces for two ounces of gold.
3. In this manner, the trader would continue to accumulate greater and greater quantities of metal, seeking "extreme" ratio numbers from which to trade and maximize his or her holdings.

Note that no dollar value is considered when making the trade. The relative value of the metal is considered unimportant.

For those worried about devaluation, deflation, currency replacement - and even war - the strategy makes sense. Precious metals have a proven record of maintaining their value in the face of any contingency that might threaten the worth of a nation's fiat currency.

Drawbacks of the Trade

The obvious difficulty with the trade is correctly identifying those "extreme" relative valuations between the metals. If the ratio hits 100 and you sell your gold for silver, then the ratio continues to expand, hovering for the next five years between 120 and 150, you're stuck. A new trading precedent has apparently been set, and to trade back into gold during that period would mean a contraction in your metal holdings.

What is there to do in that case? One could always continue to add to one's silver holdings and wait for a contraction in the ratio, but nothing is certain. This is the essential risk to those trading the ratio. It also points out the need to successfully monitor ratio changes over the short and medium term in order to catch the more likely "extremes" as they emerge.

Conclusion

There's an entire world of investing permutations available to the gold-silver ratio trader. What's most important is to know one's own trading personality and risk profile. For the hard-asset investor concerned with the ongoing value of his or her nation's fiat currency, the gold-silver ratio trade offers the security of knowing, at the very least, that he or she always possesses the metal.

[niloufar mohamadi]

hi, Sergey

Can more explain and show examples of Forex ;)

[Sergey Golubev]

I am not trading gold so I can not provide some live example about it sorry.

=========

From my previous post :

When gold trades at $500 per ounce and silver at $5, traders refer to a gold-silver ratio of 100. Today the ratio floats, as gold and silver are valued daily by market forces, but this wasn't always the case. The ratio has been permanently set at different times in history - and in different places - by governments seeking monetary stability.

First off, trading the gold-silver ratio is an activity primarily undertaken by hard-asset enthusiasts like "gold bugs". Why? Because the trade is predicated on accumulating greater quantities of the metal and not on increasing dollar-value profits. Sound confusing? Let's look at an example.

The essence of trading the gold-silver ratio is to switch holdings when the ratio swings to historically determined "extremes." So, as an example:

1. When a trader possesses one ounce of gold, and the ratio rises to an unprecedented 100, the trader would then sell his or her single gold ounce for 100 ounces of silver.
2. When the ratio then contracted to an opposite historical "extreme" of, say, 50, the trader would then sell his or her 100 ounces for two ounces of gold.
3. In this manner, the trader would continue to accumulate greater and greater quantities of metal, seeking "extreme" ratio numbers from which to trade and maximize his or her holdings.

Note that no dollar value is considered when making the trade. The relative value of the metal is considered unimportant.

[Skansi]

I might be missing a point here, but why exactly do you want to trade the XAUXAG? Or, let me rephrase that: do you need help on how to do it techically (how to produce the XAUXAG instrument at a broker who does not have XAUXAG) or do you need help on the strategies for this pair?

 

Because, if you need to produce the XAUXAG pair, you will need at least 10000 USD equity to trade normally, since you need to be able to adjust the microlots for every trade. If so, you need to make an Expert adviser which does the following:

If Buy long XAUXAG, then Buy XAU, Sell XAG, normalized for current XAUXAG value. The stop loss for XAU/USD will be the Take profit for XAG/USD and vice versa. Also, the EA must act in a way that it opens one trade immediately after you start it, and keeps it open. No additional trades. When you need a new trade, start it again. This is a very clumsy procedure but if you want it, that's the easiest method if your broker does not offer the pair already. But in the end you will end up with an instrument that is very much like an agricultural commodity in terms of moves, so you might be better off trading those. 

[Anton Nel]

Very interesting...Thank you to all.

No one can predict the future. Imagine the ratio is 1:1 - depends on demands and supplies.

Most of us thought that Gold will break $2000 in 2006-2012. 2013 shows us that Gold was @ the bottom of $1166. Person, who hold physical gold(s), waits longer to make a profit -- long term. Like what newdigital said imagine the ratio is between 120 and 150. Stuck! Who knows if ratio is going to be increase or decrease? Answer: Insider guys!

[Skansi]

Roman, I do not agree with you....

the insider guys do not know anything more than us... there are tons of examples of this, most notably the Lehman Bros and CL. Nobody knew anything.

 As for gold, I do not remember any CMT (myself included) claiming a break of 2000USD.

 Regarding bottoming, do you have any evidence that 1166 is a bottom? As far as I can see there is no sign whatsoever of bottoming, asides wishful thinking.

[Anton Nel]

Skansi:

Roman, I do not agree with you....

the insider guys do not know anything more than us... there are tons of examples of this, most notably the Lehman Bros and CL. Nobody knew anything.

 As for gold, I do not remember any CMT (myself included) claiming a break of 2000USD.

 Regarding bottoming, do you have any evidence that 1166 is a bottom? As far as I can see there is no sign whatsoever of bottoming, asides wishful thinking.

It is actually 1180, not 1166 (I am wrong). I was looked at minimum price on the right hand side of the chart.

I read hundreds of articles - they predicted that gold will break the $2000 level (Google it, you will find it).

You look at the wrong guys. Yes, there is someone that knew. 

[BullBearInvest]

Interesting story about ratio since Alexander the Great. 

 "The essence of trading the gold-silver ratio is to switch holdings when the ratio swings to historically determined "extremes."" Well, I agree, but it is also about catching the trend and should be considered as trading any security. Analysing it can be simplified by "reducing fraction" to factors that both give equal effect on both gold and silver. A particular effect of that would be, as Sergey says, "no dollar value is considered when making the trade.".

Currently, we have probably missed opportunity to short ratio and its future direction is not clear.

http://seekingalpha.com/article/3976314-gold-silver-ratio-late 

[Stanislav Korotky]

I'd suggest to read about pair trading, which is very popular strategy, and XAUUSD vs XAGUSD is just a specific case for it. Most important thing is to adjust lots according to 2 selected symbols volatilities (they are considerably different for XAU and XAG). PS. Unfortunately, as an example I can only provide a link to a discussion on russian MQL4 forum if you don't mind translating it.

[Stanislav Korotky]

It looks like an opportunity to buy XAUUSD and sell XAGUSD in 1:1 ratio at the moment.