-- Posted 22 October, 2010 | | Discuss This Article - Comments:
Currency traders have long used a grid system as a way to systematically buy into a currency at differing points and average in their positions. With silver emerging as a currency of choice among ordinary investors and even institutional hedge funds, it’s high time silver investors do the same.
Setting Up a Grid
A grid system is a very easy and defined way to invest in anything, whether it is a precious metal, a stock, or a currency. Essentially, a grid system is dollar cost averaging, but rather than buying in at different times, a grid system requires an investor buy in at different prices.
Here is an example:
Using a $2 grid, an investor would purchase a certain dollar figure (say $200) every time silver reaches a new price point. Thus, if silver rose from $25 to $29, an investor would buy two equal dollar amounts of $200 at both $27 per ounce and $29 per ounce. The grid should also allow for purchases below the current market price. Therefore, if silver then traveled from $29 to $27, another $200 buy would be placed.
A grid system is best way to dollar cost average, since it takes out the variable of time and replaces it with cold hard cash.
The grid system is based on the idea that the time at which you purchase your silver is irrelevant. Purchasing at $15 a few months ago is just the same as purchasing at $15 in 2008. The timing didn't matter, but the price point, $15, which is currently 40% under today's market price, is what matters. In contrast, time based dollar cost averaging strategies would have, in recent months, led investors to accrue silver at its most recent highest prices.
Under a grid system, investors would necessarily accrue silver at different points and effectively take out any emotion in the trading system. There are a number of ways in which this system could be even more fine-tuned.
Require Buys on Dips
Much like a trailing stop, or in this case, a trailing entry, a price averaging purchasing system could be revised to require purchases two times larger at 10% less than the current price and a normal sized buy at 5% higher than the current price. Under this system, an investor would move up the buy orders as each one is completed.
For example, if silver rises from $25 to $26.25, an investor would enter a single buy. Then, should silver fall by $2.62, the investor would buy twice as much silver as the first buy. Each time a buy is made, the new entry prices are based on the previous buy price.
What is Important
A grid system will help wean out the importance of time in a dollar-cost averaging system and promote true dollar-cost averaging. However, without getting too far from the point (and the idea that silver is a good investment at practically any price), we should never forget to recognize that the current price is the only price that matters for all buys, whether at $25 per ounce or $6 per ounce. Time, of course, is practically irrelevant – that is, if you missed out on the past year's surge.
Dr. Jeffrey Lewis