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A Bull in the China Market

Starting September 2008 the Shanghai Composite Index has been steadily rising, a remarkable performance in this dismal environment.

First, the SCI stopped falling – a feat which Western markets have yet to emulate. Secondly, it's developed a consistent sideways trading pattern which is a signal of consolidation. The Shanghai market is entering the Year of the Ox, and it may well be the start of a bull year.

The SCI continues its slow sideways activity between the lower and upper edges of the trading band. This is excellent consolidation behavior. This consolidation pattern is a good indication that the large market falls have ended.

The consolidation pattern may continue for another two or three months before there is a successful breakout and the development of a new trend. This is developing the L-shape pattern of market recovery.

This consolidation pattern started with the low on September 18, 2008. The lower edge of the consolidation pattern is the development of the support area in the narrow trading band between 1,685 and 1,750.

The upper edge of the consolidation pattern is the development of the resistance area in a narrow trading band between 2,000 and 2,100. The upper edge of the consolidation band has been tested four times starting November 2007. There has not been a successful breakout above 2,100 and this indicates the resistance strength is significant.

One important feature of the sideways pattern is the developing bullish bias. The upper level of resistance has been tested four times. The lower level of support has been strongly tested once. The retreats from the resistance level have moved towards the narrow support band area but the market has rallied before support was reached. This shows a developing bullish bias.

This bullish outlook is confirmed by the development of a consolidation and accumulation pattern. The accumulation phase is when buyers enter the market. They accumulate securities that have been falling because they believe the trend will soon change. Accumulation shows early buying in the market as investors buy shares from shareholders who have lost faith in the company. The volume of trading activity rises as the market rally develops, shown at points A, B and C. Accumulation is seen in long term chart patterns, including the L-pattern in the current market.

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The target for the breakout from the consolidation pattern can be calculated. The width of the trading consolidation band is measured and projected upwards. If the full width of the band is used, from 1,685 to 2,100, then the breakout target is near 2,600. If the inside width of the trading consolidation band is used, from 1,750 to 2,000, then the breakout target is near 2,300.

The sideways consolidation and accumulation pattern has continued for five months. The pattern may continue for another two or three months. It takes many months for a market to recover from extreme losses. At the start of the Chinese New Year the Shanghai market is the most bullish of any world market.

If you would like Daryl to chart a specific stock, commodity or currency, please write to us at ChartingAsia@cnbc.com. We welcome all questions, comments and requests.

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

Asia Economy