It is common when listening to or reading financial news for commentators to note a stock or commodity’s price is down because of “profit taking.” 1 As all markets respond to changes in supply and demand, it makes sense for financial instruments to decline if there are a lot of sellers. However, when the reason is profit taking, it is worth understanding what that action implies.
The Reality of Market Cycles
The simple reality of financial markets is they operate in cycles. While the study of these cycles is a science and they are better understood now than ever, they still remain a great mystery. However, all experienced and knowledgeable investors understand that cycles are a regular occurrence.
Rather than fearing them, they learn how to turn them to their advantage, depending on their investment goals and methods. 2 For example, the Gold-to-Silver Ratio is based on the concept of both general cycles and cycles within different commodities.
Selling at the Top
The over-worked wisdom often quoted about how to be successful in the markets is to “Buy Low, Sell High.” Of course, that goal is quite hard to consistently achieve, but it does state an important point of wisdom. However, that wisdom carries different significance for short-term and long-term investors.
In today’s markets, there are many buyers of gold and silver that are both short-term traders and speculators. In fact, it is important to understand the difference in “paper gold” and physical gold, as paper gold is often the source of wide swings in gold and silver prices. 3 Simply put, those who buy such things as gold ETFs, gold certificates, gold futures, and other items are most often speculators and traders who are playing the small increases and dips in prices.
For these short-term players, selling on a small increase is a way to lock in the profits they need to support their investment business model. These market players will generally execute a large number of trades, trying to minimize losses and generate a large volume of small profits.
Unfortunately, many speculators follow something of a herd mentality, and they will fail in their efforts to buy and sell where they want to. 4 This is due to the fact that the large number of their fellow buyers and sellers cause market shifts because of their buying or selling rather other than true fundamental factors.
Taking the Long View
On the other side of the market are the long-term investors who buy gold for security and wealth. These are those patient individuals and traders who look at a number of indicators that affect prices over years and decades, not days and weeks. Just a few of these market factors include:
- Growth or decrease in relative supply and demand (including those things that will affect supply and demand, such as costs of production and technology)
- Global economic trends and economic realities
- Central bank policies around the world
Heavy users of gold, such as electronics firms and jewelry manufacturers, also look at gold prices from an intermediate to long-term perspective. This helps them better control inventories and moderate swings in their costs of production.
The only way to make a profit with a commodity is to sell it for more than it cost to buy. This is why long-term investors like to see price drops during market cycles. With a firm belief in the future price of their purchase increasing, they see any declines as an ideal time to buy. Such purchases average down the overall costs of their holdings, generating even larger profits when any sales are made.
Buying low and selling high is the objective, while achieving it takes advice, wisdom, and patience.
2 – http://www.investopedia.com/articles/technical/04/050504.asp
3 – http://www.investing.com/analysis/paper-gold-vs-physical-gold-and-the-economy-200134048
4 – http://www.gold-eagle.com/article/gold-speculators-trimmed-their-bullish-net-positions-second-week