Moving Averages as Resistance

Moving Averages as Resistance

The same characteristics that are found in an up-trending stock are also found in stocks that are in a downtrend. For example e, a price that breaks down through a major moving average could eventually bounce back up to test that moving average. If it fails, then the trend will be taken lower. The continued downtrend will usually breach the recent low. If the other major moving average is below the failed moving average, it now becomes the potential target. Understanding these basic movements in prices, it does not take more than a few seconds to analyze whether a price will be affected by the moving averages.

A downtrend in price can be easily monitored when a major moving aver­age is recognized as being a resistance level. Adding another analytical ele­ment, when analyzing a trend, increases the probabilities of being in a high probability trade. Logic dictates that if a price does not seem to be able to push through an observed resistance level, the more often that occurs, the higher the probability that it will continue its downtrend. As can be observed in Fig. 3-8 (opposite), the KLIC chart, from the peak in price in January, of 2004, every time the price climbed up towards the 50-day moving average, sell signals would appear.

This observation should not have taken too much analysis. If the stock was bought when candlestick signals and stochastics dictated, there should be the preconceived awareness that the uptrend has a high probability of running into resistance near the 50-day moving average. Being prepared for that occurrence makes viewing the candlestick sell signals, at those levels, that much more credible.

Knowing moving averages are important technical levels for many inves­tors, it becomes important to understand what is happening at those levels. The candlestick signals provide that information. If a moving average acts as support, there should be the anticipation of a candlestick buy signal formation. Conversely, if the candlestick formations do not reveal any buying strength at those levels, it becomes apparent that the important support level was not having an effect on the downtrend. This is just simple logic. Nothing more than analyzing what is happening at supposedly important technical levels.

Illustrated in Fig. 3-9, the MPS Group Inc. chart in late May, spinning tops formed on the 200-day moving average, confirmed with a bullish candle and stochastics.

The uptrend did not stop at the 50-day moving average. A large bullish candle at the 50-day moving average indicated this to be a support level until prices topped out on the first of July. What was the first logical support area? Of course, the 50-day moving average.

However, as can be seen, there were no confirmed buy signals at the 50- day moving average in early July. That should have given the indication the next support level would be the 200-day moving average. The large dark candle that came down through the 200-day moving average, in mid-July revealed that the 200-day moving average was not going to act as a support level either.

The failure of the 200-day moving average did not show any confirmed buy signals until the bullish Harami down in the $8.00 range. If the investor had been short during this downtrend or an investor was waiting to go long at important support levels, it became obvious that those support levels were not going to act as support. Simply stated, if a technical level has the potential of acting as support, it is logical a candlestick buy signal will confirm that. The lack of a candlestick buy signal will demonstrate that it is not.