Asymmetry between Uptrend and Downtrend Identification: A Tale of Moving Average Trading Strategy

Abstract

Most market participants are risk adverse and people tend to close their long positions once they perceive a formation of downturn in the market. Large sudden price drops can always be observed near the end of uptrends. On the other hand, people tend to have their own preferences in deciding the market entrance timings and large sudden price changes are relatively less commonly observed near the end of downtrends. Typical Moving Average strategies employ the same approach, using a single pair of time series, to locate the ending points of uptrends and downtrends. This approach does not consider the asymmetry of price changes near the end of uptrend and downtrend distinctively. To cater for the differences, a new approach using distinct pairs of time series for locating uptrends and downtrends is proposed.

Performance of the proposed strategy is evaluated using stock market index series from 8 different developed countries including US, UK, Australia, Germany, Canada, Japan, Hong Kong and Singapore under 3 moving average calculation methods. The empirical results indicate that the proposed strategy outperforms the typical strategy and the buy-and-hold strategy. Recommended heuristics for selecting an appropriate MA length will also be addressed in this study.

Keywords: Technical trading, Moving average, Financial markets, Trend identification, Asymmetrical information, Risk averse

JEL Classification: C19, C63, G10