On Monday, China's securities regulator, in a fresh effort to prevent a stock market crash, warned companies against raising large sums of capital through the issue of new shares. The warnings reflect the alarm felt by Chinese authorities over the sagging stock market. The Shanghai Composite Index is now 32 percent below a record high of 6,092, hit last October.
In February, the SCI plunged because of concern about the market's ability to absorb big supplies of new shares, including huge offers planned by Ping An Insurance and Shanghai Pudong Development Bank.
Even if regulators impose a complete halt to new fund-raising, that may not be enough to keep the market afloat. Investors are also worried by huge amounts of new shares that will become freely tradable this year as lock-up periods related to initial public offers and reform of companies' state shareholding structures expire.
The official China Securities Journal estimated last week that 401 billion yuan of such shares would become tradable in March. The market is also worried by rising Chinese inflation, at an 11-year high, and by the threat of a U.S. economic recession.
With this in mind, we thought it would be timely to chart the Shanghai Composite Index and see what direction it might take.
The fall below the 4,300 support level is a critical confirmation of a continued downtrend on the SCI. The fall below the long-term trend line on January 21 was confirmation that the prolonged Shanghai uptrend was moving into a new trend phase. The trend line started in November 2006 and had effectively defined the rising trend for 2007.
The key question: Is this a new genuine downtrend, a temporary correction or a consolidation?
Unlike other markets there is no evidence of long-term reversal patterns such as a head and shoulder pattern, a double top or a rounding top.
The technical weakness of the previous uptrend was the lack of substantial consolidation areas as the market rose. Support is created by market consolidation behavior, and not by the value of a moving average. This means the potential consolidation and support levels in a declining market are widely spaced.
The first important support level is at 4,800. This did not hold, and now will provide a resistance point for any future trend rise.
The 4,300 support level is significant and currently under test. It was a decisive resistance level in May and June, 2007 and more recently acted as a rebound support level. The rebound from support at 4,300 is part of the consolidation activity of the market.
This rebound developed a short-term rally that reacted away from the lower edge of the long term Guppy Multiple Moving Averages (GMMA) group of averages.
A good and successful retest of support near 4,300 gives more strength to the next rally. The usual development for a trend change contains several unsuccessful rallies. These are fast rises that collapse with a fast price retreat. The consolidation rebound features we look for are these:
- A successful retest of support near 4,300
- The second rally that penetrates more deeply into the long term GMMA
- The retreat after the second rally should not fall as low as support at 4,300
- The third rally moves above the upper edge of the long term GMMA. Also the long term GMMA shows evidence of compression and begins to turn upwards
- The retreat after the third rally uses the lower edge of the long term GMMA as a support level. The fourth rally develops from this new support level.
This pattern of behavior is often seen, as a new strong uptrend develops.
Traders are also very alert for the possibility that support will not be successful at 4,300. A sustained fall below this level is very bearish. The next support level is near 3,600. A fall below support at 4,300 could develop into a very rapid fall to support at 3,600.
The Relative Strength Indicator (RSI) divergence signal is an effective leading indicator of trend change with the Shanghai index. The RSI divergence signal has not developed. The first RSI and significant index low was created on February 1. A second significant index low has not yet developed. When this develops, traders will look for a confirmation RSI divergence pattern. An RSI divergence signal confirms the consolidation or rebound has the potential to develop into a new uptrend.
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