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Charts Signal End for China Equity Downtrend

China remains one of Asia's worst-performing stock markets this year, but there are reasons to believe the prevailing downtrend for the long-time laggard may be coming to an end.

In broad terms, the benchmark Shanghai Composite Index is continuing part of a long term trend breakout pattern. There are three defining features on the weekly chart.

(Read More: This Worries Us Most About China, Says World Bank)

The first feature is the long term downtrend A. The breakout above this line in December 2012 was very significant because it signaled a change in the long term trend behavior. This change was also supported by the change in the relationships in the Guppy Multiple Moving Average (GMMA) indicator. The GMMA use two groups of moving averages. The short term group shows the activity of traders. The long term group shows the activity of investors.

This change in relationships doesn't mean a smooth new uptrend, but it did signal the end of the prevailing downtrend.

(Read More: Beijing Steps Up Efforts to Shore Up Stock Market)

The second feature is the strong resistance level near 2440. This was a resistance level in March and May 2012 and it provided a strong barrier to the rise in February 2013. A move above this level will be exceptionally bullish and set upside target between 2780 and 2900. These targets are calculated from the third feature of the chart.

The third feature is the support band between 2000 and 2110. This is a narrow consolidation band that developed between September and December 2012.

The current index activity may test the upper level of this band near 2110 as a support level prior to developing a new uptrend continuation band retest of resistance near 2440. This type of larger retreat and rebound is the type of activity we are also seeing in other international markets.

This pattern of index activity of rally and retreat is also part of a long term fan pattern breakout. This is a long term trend reversal pattern. A fan pattern develops as a trend starts to change direction in a downtrend.

(Read More: Worst-Case Scenario for Markets: 'Great Slowtation')

Fan lines are drawn from a single starting point. They show a slowing of the trend. These are trend line A, B and C on the chart. Traders look for other signs of bottom and reversal prior to trading in anticipation of a new uptrend. Fan lines tell the trader the downtrend is slowing. The Shanghai Index has a history of developing long term fan trend breakouts.

The fan pattern uptrend breakout may take 4 to 8 months to develop. The long term uptrend breakout may also take 4 to 8 months of development before the new uptrend is finished. The fan pattern sets the environment for the market. Investors must also watch the shorter term uptrend and retreats inside the fan pattern that continue for 6 to 8 weeks.

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