Hong Kong Economic Journal --- 4 Dec, 2000

Moving average is one of the most popular technical analysis tool used by practitioners. Conventional wisdom dictates that when price closes above the Moving Average, one should go long. On the other hand, when price closes below the average, one should go short. In the long run, this is a very profitable strategy. However, at times when the market is consolidating, price tends to fluctuate above and below the average randomly, causing the strategy to suffer from losing streaks.

Nevertheless, the Moving Average is a very useful benchmark of support and resistance levels. When price breaks above or below it, it means the resistance or support is breached and a trend should then follow.

Figure 1 shows the Modal line chart of AT&T (Symbol: T). AT&T is the biggest telephone company in US, just like the PCCW in Hong Kong. Compared to the historical high of 62, the current price level has already dropped nearly 70%. The 40-day exponential moving average is also shown in the figure. However, unlike the traditional moving average, the moving average in the diagram is calculated using Modal Points instead of closing prices. The official Prosticks website allows the users to specify whether to calculate the moving average using closing prices or Modal Points.

It seems that there is a regional preference with regards to the choice of Moving Average parameters. In Hong Kong, people like to use 50-day Moving Average, while in the United States, 40-day is more preferred than 50-day. There is no theory to account for the cultural differential, just a regional custom.

Refer to Figure 1 again, notice how powerful the Moving Average acts as a resistance level to the downtrend. Whenever price rebounds from a low price to the Moving Average, severe selling pressure resurfaces and the downtrend resumes. (see the places marked with arrows in the figure).

Thus, from this chart, we see that the Moving Average has been imposing significant resistance to price all the way throughout the downtrend. We should then deduce that the average should continue to act as a resistance to price in the future. As such, not until the subsequent Modal Points can manage to break above the average, the trend is still down.

Though the Figure shows that the Modal Points never rise above the average, if we look at the Candlestick chart of this stock (not shown here), we will see that at times the day high or close of some bars temporarily breaks the average, creating false breakouts? Thus, if one adopts the Moving Average breakout strategy in trading, one should wait until the Modal Point breaks the average, rather than merely the day high or day close.