Gold Shows a Type 2 Rainbow Convergence

On June 12, 2024, the day of the FOMC meeting announcement, gold prices were making a rebound up move after pausing unchanged for 2 days in a row.  Making that up move, and then moving downward on June 13, constitutes a big "tell" about what lies ahead.

This week's chart is one I show frequently in my Daily Edition.  It features 4 moving average type lines, which are explained here: https://www.mcoscillator.com/learning_center/kb/market_data/calculating_indicators_in_daily_edition_table/.  Only the middle two lines (red and green) are true exponential moving averages (EMAs).  The others are related indicators, which behave somewhat like moving averages, but which have interesting additional properties which make them interesting to include in the chart.

When those 2 EMAs, the 10% Trend and 5% Trend cross, we actually see all four moving averages come to what we call a "rainbow convergence".  These events are important, and the way in which they are important varies depending on how prices are behaving at the moment of the convergence.

In a Type 1 rainbow convergence, prices make an accelerated short term move which pulls the four lines together all at once.  Here is an example from a few months ago:

You can see in that chart that gold prices reached a short term top right as the four lines came together, and this is a great example of what usually happens.  In a Type 1 convergence, prices typically pause starting at the moment of the convergence.  That pause can be just a rest break or the start of a reversal.  Which of those it is depends on how prices do when they make a test of the blue Price Oscillator Unchanged line.  In this particular case, that line failed as a support agent, and gold futures prices pulled back further. 

In a Type 2 convergence like what we appear to have in the top chart, prices make a retracement back toward the price-time point of the impending convergence.  The message of a Type 2 convergence is that the price trend direction which preceded the retracement should reassert itself.  So for this week's chart featuring gold prices, that would mean prices start downward again after the brief retracement move back up toward the impending convergence.  And that seems to be what we are getting. 

The determination of a Type 2 convergence only has a limited duration utility.  It will not tell us how far the resumed trend will travel, just that there should be one.  And a chartist must be careful when making such determinations, because a retracement back toward an impending rainbow convergence does not necessarily have to stop retracing.  It could keep on going.  So one should not be too eager about making such determinations too early.

One other caveat to remember is that these are specifically chosen examples for the purpose of illustrating a phenomenon.  There are exceptions one can find, where prices did not behave exactly as this description dictated.  No charting interpretation works perfectly all the time. 

For both of these charts, the two main EMAs that drive this phenomenon are the 10% Trend and 5% Trend of closing prices.  Some analysts would call these a 19-day and 39-day EMA, but we prefer the originalist terminology coined by the late P.N. Haurlan, who first introduced the use of EMAs for tracking stock prices back in the 1960s.  The numbers 10% and 5% refer to the smoothing constants, which determine how fast the EMAs move toward where prices are going. The larger the smoothing constant, the faster the response. See this page for more on EMA calculations.

The same principle about crossovers and price response can work with other moving averages.  I wrote here about how it works with a 50-day simple moving average (SMA) crossing a 200-day SMA.  This puts a whole different spin on interpretation of a "golden cross" or a "death cross".  The implication really depends on how prices are behaving at the moment of the crossing.