Low downside. High upside.
Whether you're a long-term investor or a short-term trader, your path to success is the same: Find opportunities with low downside and high upside.
Note the order of these requirements. It's important. Great investors and traders focus on limiting downside first. Only after considering the downside risk do they focus on upside potential.
As legendary trader Paul Tudor Jones said in his interview for
Market Wizards – the best trading book of all time – "
The most important rule of trading is to play great defense, not great offense."
Today, we see a great trading opportunity in precious metals. The prices of gold, silver, and platinum are all near multiyear lows. This gives us a simple way to structure low-downside trades in the sector.
We're especially interested in silver...
We consider silver "hard money," like gold. It has been used as a currency throughout history... And folks turn to it as a store of wealth when they're worried about paper currencies. Silver is a form of
financial-disaster insurance.
But lots of people don't realize the amount of silver used for industrial purposes is three times larger than the amount folks buy for investment. Last year, around 600 million ounces of silver were used for things like solar panels, photography, and connections for electronic devices... And about 250 million ounces were used to create bullion coins and bars. Another 215 million ounces were used for jewelry.
So there's a good case for higher silver prices even if you're not concerned about the economy.
Silver soared from $4 an ounce in 2001 to $21 in 2008. Then, the 2008 credit crisis stoked the fire. After a brief panic, which sent silver back down to $9 an ounce, silver rocketed up to its all-time high of nearly $50.
But the global financial system didn't fall apart as some expected. Silver prices fell. As you can see in the chart below, silver is now trading at $16 an ounce. That's down 68% from its peak... back to where it was in early 2010.
Low silver prices are putting a strain on silver producers. They get paid less for doing the same work with the same costs. Many producers are losing money... and have to put higher-cost mines on hold.
One popular silver-miners fund, the Global X Silver Miners Fund (SIL), is down 70% from its peak.
But decreased silver production means a smaller supply. And low prices should lead to higher industrial and investment demand. It's a recipe for higher silver prices to come.
In the one-year chart of silver below, you can see this change may already be underway.
If prices continue to move higher, silver producers will benefit... And shares could soar.
Keep in mind, silver miners are among the most volatile securities in the market. They boom and bust like crazy. But after the recent bust, it's a great time to make a bullish bet.
There are three simple ways to reduce downside risk...
| 1. |
Buy a diversified fund like SIL, which holds shares of 23 different mining companies. This removes the risk of shares tanking on one company's bad news. |
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| 2. |
Use a stop loss. You can sell your shares for a small loss if silver drops below its recent lows. |
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| 3. |
Keep your position size small. This ensures you won't take a catastrophic loss on your overall portfolio if silver suffers a sharp decline. |
On the upside, if the small uptrend in silver prices turns into a big uptrend, your gains could be huge. A 100% gain isn't out of the question.
Remember, this is a speculation... So you have to "play great defense." With silver near multiyear lows, we have a natural place to cut our losses if we're wrong.
It's just the type of low-downside, high-upside setup we like to participate in.