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Secret 23

Go with the relative strength

I'm not referring to the RSI (relative strength index, a popular indicator of oversold/overbought). What is important is that you follow the trend of each market and always buy the strong one and sell the weak one. This is especially important for related markets. Silver and gold are both precious metals and generally move in the same direction; however, they move at different speeds. In early 1987, silver started to run, and in a short time, it ran up almost $6 per ounce, representing profits of close to $30,000 per contract. We had clients who did not want to “chase the market” after silver made its first $1 run-up, but they had no hesitation buying gold. It was, after all, cheap in relation to silver and would have to catch up eventually, right? Gold did run up, about $60 per ounce, or $6,000 per contract. Not too bad, but you would have made five times more by buying the strong one instead of the weak one. Moves of this nature don't come along very often.

If hogs are going up and bellies are heading down, you should sell the bellies if your trend indicators tell you to do so. It doesn't matter that they're both pork products; the markets are telling you no one is eating bacon—at least not now. When I first started in the business, I remember bellies (which usually trade at a 10¢ to 20¢ premium to the hogs) were trading at the same price as hogs. All the boys at Merrill Lynch said this was a slam-dunk—you just had to make money spreading bellies and hogs. (Buy the bellies and sell the hogs.) This made perfect sense. The logic was sound: How could a finished product ever sell for less than the raw material? We all piled on this one, and you probably can guess what happened. The bellies continued to head south and the hogs north until the bellies were selling at a $5 discount to the hogs. This was a loss of $2,000 per spread at the time in a “no risk” trade (and, of course, we overtraded this one because it “couldn't lose”).


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