Hong Kong Economic Journal --- Sept 18, 2000

There are two streams of thoughts concerning how to use trendlines. Take the support trendline as an example. One stream of thought is trend following. When price falls below the support trendline, they sell. Otherwise, they do nothing. As readers of this column should know, we belong to this category.

Another stream of thought is trend reversal. Followers of this school will wait until price falls to the vicinity of the support line and then buy. Their rationale is that support lines will have supporting effects and thus they should bet on rebound from this support trendline when price falls there. The problem is that it is very difficult to objectively define vicinity? Some practitioners tend to use a percentage number. Thus, they will buy when price falls to, say 2% above the support trendline and then place their stoploss point 2% below the trendline. However, where does this figure 2% come from? Why not use 1% 3%, or 2.5% instead?

Figure 1 shows the Candlestick chart of the Dollar Yen. L1 is the support trendline drawn by connecting two major low A and B together. As can be seen, at C, when price fell to the vicinity of L1, a rebound occurred which propelled price upwards by 300 points within a week or so.

On hindsight, trend reversal followers would claim that they should be able to catch this rebound by drawing the trendline L1 and buying when price fell near there. However, ex-ante, it is very difficult. At C, the breakpoint of the trendline is 104.57 but the day low is 104.75. That means had we waited until price fell to anything between 104.57 and 104.74, we would have missed the entry. The problem is, can we really forecast beforehand that price would not fall to 104.57 but 104.75 instead?

Our Prosticks chart has good news for these trend reversal catchers. Refer to Figure 2 which shows the Modal line chart of the Dollar Yen. L2 is the support trendline drawn by connecting the Modal Points of A and B together instead of the lows. As can be seen, at C, the Modal Point lies exactly right on the trendline, signifying that the trendline really does have support effect on price, right at the Modal Point. A large amount of buy orders accumulated there. Traders who like to pick market bottoms, when seeing this, might be confident to buy the next day after the market opened and still caught the rebound, even they had guessed the day low incorrectly and missed the entry at C.