• A simulation to represent the trading process of a gold trader in 2023

• Using a generic trading strategy, the results and the importance of stop losses are examined

• Central bank meetings and US labour market data were the main causes of sizeable moves

Being a retail trader is an extremely challenging endeavor that tests a person’s abilities on a daily basis. Being aware of the intricacies of trading, the performance of a fictional account was looked at based on a strategy of daily trades.

The simulation was kept simple by trading only one security. Gold was selected and the trade period was the entire year of 2023. The fictional account had a starting balance of $10,000 and the plan was to trade every day. The main assumption was that the fictional trader would open a position at the start of each trading session and close this position at the end of each trading session. This means that the trader would avoid possible overnight fees such as swap charges.

The next key step was to identify a trading strategy. In this case, daily return gold data since 2010 was analysed and it was decided to “sell gold” every Monday and “buy gold” in the remaining weekdays. In a nutshell, one sell order and four buy orders per week.

The margin requirement is 5% for gold positions, which translates to a 20:1 leverage. This means that a trader can open a position that is worth 20 times more than the deposit required by the broker. This leverage can be larger in certain circumstances, limiting the deposit required for each position but that would also increase the risk associated with each trade.

One “standard lot” in gold is 100oz (or units). This is different from foreign exchange pairs where a “standard lot” refers to 100,000 units. Considering the 5% margin requirement and the starting amount is $10,000, it was decided to trade 0.1 standard lot in gold, which translates to 10 units per trade.

Before starting to trade, the possibility of using take profit targets and stop losses was considered. The importance of these two trading factors cannot be highlighted enough. However, they must be correctly selected. If a stop loss is too tight i.e. it allows for only a small adverse move in gold price, it would result in repeated stop loss triggers, restricting a trader’s ability to catch ‘big’ movers. On the flip side, setting very wide profit targets and stop losses could mean unattainable targets.

After careful consideration, the risk amount per trade was set at 1.5% of the running account’s balance. This means that in periods of consecutive profitable trades, the amount risked would increase and vice versa. In addition, the profit target was fixed to be twice the stop loss amount.

The exercise produced interesting results. Table 2 below presents the trading details, including a breakdown based on the buy and sell orders. The fictional portfolio executed 258 trades, 207 buy trades and 51 sell trades. The final amount came to $13,105, a 31% return. The overall success rate for the 258 trades was 49.2%, which practically means that half of the trades, long or short positions, closed in profit.

Firstly, table 2 above shows the importance of using stop losses. There were a total of 25 times that the daily trades hit the stop loss level. In certain cases, this protected the fictional portfolio from suffering stronger losses. And to put this situation in context, the account lost a total of $4,352 due to implemented stop losses. Without stop losses, this amount would have risen to $6,916. Another confirmation of the importance of this useful trading factor.

On the flip side, the profit targets were reached just 7 times. A net profit of $2,372 was recorded, which would have risen to $3,268 if take-profit rules were not used. Put alternatively, perhaps the selected profit target was too tight for the gold market in 2023.

In retrospect, 2023 was overall a very good year for gold, as it was up almost 15% in dollar terms. Hence, a simulated strategy that was long gold 80% of the time and short only 20% during that period, was expected to do very well. Having said that, the trading strategy used in this trading exercise managed to outperform the simple buy-and-hold position in gold, but, given that it employed substantial leverage, maybe even more was expected. Of course, the buy-and-hold strategy also doesn't use stop losses or take-profit rules, so comparing the two is not as simple.

The trading exercise allowed further investigation of the qualitative aspect of trading. More specifically, which market events led the positions to reach their profit target or hit the stop loss levels? This could give a sense of what caused significant gold volatility during 2023, which in turn impacted the fictional account.

Next, market events themselves were examined i.e. central bank events, central bank speakers and data releases, that took place before and on the day of each trade that hit the profit target or the stop loss. Predictably, there was increasing volatility in gold during 2023 on days that (a) central bank meetings were held, (b) there was a plethora of Fed speakers and (c) the US labour market statistics were released.

At a lower frequency, it was observed that the release of the US durable goods report, US retail sales and the preliminary release of the University of Michigan consumer sentiment were causes of increased volatility. Surprisingly though, the release of the US CPI and PCE inflation indicators did not make the list of the top reasons for increased gold volatility during 2023.