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Shanghai Composite eyes potential rebound pattern

Chinese Premier Li Keqiang confirmed at the National People's Conference last week that China's gross domestic product growth target for 2014 was set at 7.5 percent. However, he indicated that there is some tolerance for slower growth, which made world markets shudder.

The Shanghai Composite Index was also uncertain by this indication as it moved to potentially complete a broader strategic reversal pattern. The retreat from the February 2014 high of 2177 is now near the 1980 support area, indicating that the index is developing double-bottom behavior near the 1980 level.

The double-bottom pattern develops rebound activity; this behavior is shown by the thick lines on the chart. Traders and investors should wait for a retreat and rebound within the environment of a double-bottom trend reversal pattern.

(Read more: Chinese Premier hints at tolerance for slower growth)

The double-bottom pattern starts with the downtrend and a rebound from the low at 1984. The rally from 1984 reached a high of 2177 before collapsing into the current downtrend. The high at 2177 is the top of the middle peak of the 'W pattern'. This creates the potential for a W pattern trend reversal, also called a 'double-bottom trend reversal pattern.' This pattern would be confirmed if the index finds support near the 1980 area, thus investors and traders should wait for this downtrend to move towards 1980 has developed.

The double-bottom pattern sets two upside targets. The first target is near the peak of the middle of the W and suggests a rally rebound from 1980 with a target between 2150 to 2177. The distance between the bottom at 1980 and the peak of the middle of the W is measured and projected upwards above 2150 to give a second long-term target near 2310. This long-term target, which could take several months to achieve, is reasonable because it is a historical resistance level.

(Read more: Chinese Premier hints at tolerance for slower growth)

Danny Hu | Flickr | Getty Images

If the rebound from 1980 fails to breakout above 2150 then the Shanghai index will move into an 'L shaped' recovery pattern. Here, an L shaped pattern would be a sideways consolidation pattern between 1980 and 2150.

A sustained fall below 1980 would be very bearish. The next strong historical support level is near 1725, near the October 2008 low.

The key feature in the next 5 days is the behavior of the Shanghai index as it tests support near the 1980 level. A strong rebound from this level would confirm the development of a double-bottom pattern.

(Read more: Marc Faber: Unchecked bull market leads to big declines)

Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders – www.guppytraders.com. He is a regular guest on CNBCAsia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.

  • Daryl Guppy is an independent technical analyst who appears frequently on CNBC Asia.

Asia Economy