Gold Silver Chart Ratio Strategy (Backtest)
Last Updated on April 18, 2023
If you have been trading or just following the gold and silver markets, you must have heard about the gold-silver ratio. What does the gold-silver chart ratio strategy mean?
The gold-silver chart ratio strategy is a technique for trading the two precious metals (silver and gold) using the relationship between their prices. The gold/silver ratio shows the number of silver ounces you would need to trade to receive the value of one ounce of gold at current market prices. It is a powerful trading signal that can help to identify buying or selling opportunities in the two precious metals.
In this post, we take a look at the gold/silver ratio and we backtest a gold silver chart ratio strategy.
What is the gold/silver ratio?
The gold-silver chart ratio strategy is a technique for trading the two precious metals (silver and gold) using the relationship between their prices. The gold/silver ratio shows the number of silver ounces you would need to trade to receive the value of one ounce of gold at current market prices. For example, if the price of gold is $900 an ounce and the price of silver is $15 an ounce, then the gold-silver ratio is 60:1.
The gold/silver ratio is a powerful trading signal that can help to identify buying or selling opportunities in the two precious metals. While the ratio might seem like a simple indicator, it is the oldest continuously tracked exchange rate in history. The ratio is important to traders because gold and silver prices have such a well-established correlation and have rarely deviated from one another. Traders use it to know when to buy or sell either of the two metals. In fact, the gold-silver ratio has been one of the most reliable technical indicators for a ‘buy’ signal in silver, whenever the ratio climbs above 80.
How does the gold/silver ratio work?
The gold/silver ratio is calculated by dividing the current gold price by the current silver price. It does not matter the currency you price them, as long as you use the same currency for each metal and for the same weight. So, they can be priced in US dollars per troy ounce or euros per kilogram, or pounds per ounce.
As an example, if gold trades at $700 per ounce and silver at $14, the gold/silver ratio would be 50:1. Similarly, if the price of gold is $8000 per ounce and silver is trading at $10, the ratio would be 80:1. Since the removal of the gold standard, the prices of gold and silver are left to float and so does the gold/silver ratio.
When the gold/silver ratio is high it means that gold is expensive compared with silver, or the other way around: silver is cheap relative to gold. Here are the four ways the ratio can increase or decrease:
- The gold/silver ratio increases when the price of gold increases faster than the price of silver.
- It decreases when the price of silver increases faster than the price of gold.
- It increases when the price of silver decreases faster than the price of gold.
- It decreases when the price of gold decreases faster than the price of silver.
How do you use the gold/silver ratio?
You use the gold/silver ratio as an indicator when trading gold and silver and other related instruments.
Generally, traders use the ratio on a contrarian or mean-reversion basis. That is, when the ratio is very high (which means that gold is relatively overpriced and silver is relatively underpriced), traders believe that the ratio will drop, so they may decide to buy silver and take a short position in the same amount of gold with the hope that the spread would contract.
On the flip side, when the gold/silver ratio is very low (which means that gold is relatively underpriced and silver is relatively overpriced), traders believe that it will rise, so they go long on gold and short on silver. However, what constitutes a high or low gold/low ratio for a contrarian play will depend on you to decipher from your back-testing and research.
Most traders use this mean reversion approach on the futures market. They buy gold contracts and sell silver contracts when the ratio is very low and flip their trades when the ratio rises again. Apart from futures, you can also trade options. You can buy puts on silver and calls on gold when the ratio is low, and when the ratio is high, you can buy puts on gold and calls on silver. The idea is that the spread will diminish with time if the ratio is high and increase with time if the ratio is low. Another option is to trade gold and silver-related ETFs.
What is the historical gold-to-silver ratio? Gold/silver ratio history
Today, the gold/silver ratio floats and swings widely. But it wasn’t that way in the past. For hundreds of years before the gold standard was changed in the 20th century, the gold/silver ratio was set by governments for purposes of monetary stability and was fairly steady.
For example, in the Roman Empire, the ratio was officially set at 12:1. The U.S. government fixed the ratio at 15:1 with the Coinage Act of 1792. In 1803, the French fixed the ratio at 15.5:1. But the era of the fixed ratio ended in the 20th century as nations moved away from the bi-metallic currency standard and, eventually, off the gold standard entirely in the 1970s.
The average gold-silver ratio during the 20th century was 47:1. In the 21st century, the ratio has ranged mainly between the levels of 50:1 and 70:1. It broke above that point between 2018 and 2020, rising to a peak of 114.77 in 2020. The lowest level for the ratio was 35:1, which was recorded in 2011.
Gold silver chart
To get a better “feeling” of how the gold silver ratio looks like we have made a chart for you of the ratio:
The chart above is simply the gold ETF (GLD) divided by the silver ETF (SLV). As you can see, the ratio is pretty volatile.
What are the best settings for the gold silver ratio?
Generally, traders take a gold/silver ratio of 35 as low, and until the recent spike between 2018 and 2020, a value above 80 is considered high. However, the 2018-2020 spike above 110 shows that what is considered high may not be high enough in certain economic situations. The only way to know the best setting for the gold/silver ratio if you intend to use it for a mean-reversion futures trading strategy is to backtest and find the number that gives the best performance.
Gold silver chart ratio strategy (backtest)
Let’s go on to make a backtest of a gold silver chart strategy. The backtest has the following settings and trading rules:
- We use the RSI indicator to make an RSI indicator strategy of the gold silver ratio.
- When the 5-day RSI is above 75 we buy at the close.
- When the 5-day RSI falls below 50, we sell at the close.
This simple gold silver ratio strategy has not performed well on GLD:
The trading strategy buys on strength, the opposite of mean reversion, and has a positive expectancy. But the equity curve is pretty erratic and is nowhere near a tradable trading strategy.
Perhaps SLV performs poorly when GLD is strong? This is the equity curve of SLV for the exact same parameters as above:
Our final backtest of the day is a pair trade of the above two backtests: when the 5-day RSI is above 75 we buy gold (GLD) and sell short silver (SLV). We exit when the 5-day RSI falls below 50.
The equity curve looks like this:
As you can see, the gold silver pair trade strategy shows a flat development.
Is the gold/silver price ratio an indicator for the equity markets?
Many pundits argue the gold silver ratio can be used as a gauge to measure the risk appetite for stocks.
We did a lot of risk on/off strategy backtests, but we failed to find any meaningful profitable trading strategy.
Gold Silver Chart Ratio Strategy – ending remarks
There are endless technical trading indicators but we fail to see how the gold silver chart ratio is of much help.
Even as an indicator for gold and silver strategies we fail to find any robust trading strategies. However, that doesn’t mean it doesn’t exist, but we consider commodities and metals as extremely difficult markets to trade. Most commodity trading strategies fail to be profitable and robust for long periods of time.
Here you can find more info about our best trading strategy in different asset classes.