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Shanghai Must Hold Above 2,400 to Avoid the Bear

Friday, 21 Aug 2009 | 2:04 AM ET

For several weeks the continuing expansion of separation between the long-term and the short-term Guppy Multiple Moving Averages in the Shanghai Index was signaling a bubble and the potential for a correction retracement.

A correction in the order of 10 percent to 15 percent was expected and would drop the index back to the underlying trend strength. The current retreat has some wondering if this is a new bear market. It’s more an application of the Chinese strategy 19: Pulling the Firewood from Beneath the Cauldron. This cools the market back to a sustainable uptrend.

There is a feeling that the Chinese Government will step in and rescue the market. This, of course, is no different to the US government establishing the Troubled Asset Relief Program (TARP) or adjusting interest-rate policy to manage market falls. It’s not the methods that are used that are important. It’s the feeling in the market that such action is possible that helps to restore stability. The technical analysis of the market indicates where support is located.

The long-term trend strength for the Shanghai Index is created by the long-term trend line. This trend line starts in December 2008. It uses the lows created in January and March. These are three additional rebound points that anchor the position of the long-term trend line 1.

In April the index began to move away from this trend line. Trend line 2 defined the middle trend. The acceleration of trend behavior was defined by trend line 3, which started in May.

We expected a retreat to near the value of the middle trend line. The value of this trend line was near to the historical support at 3,000 and the value of the lower edge of the long-term GMMA. The failure of support at these levels confirmed that this was not just a temporary retracement. The fall below historical support near 2,900 confirmed this was a change in the nature of trend behavior.

When the market fell below trend line 2 the long-term GMMA started to compress and turn down. This indicated investors had also begun to sell. This confirms a significant trend change.

The key questions now concern the support areas for this trend change. These are consolidation areas that provide a rebound area for a continuation of the broader uptrend in the China market.

The first of these support areas is provided by trend line 1. The value of this support area continues to rise with the trend line. A rebound from this area encounters resistance near 3000 and resistance again near the value of trend line 2 around 3,100. A successful rebound from the area near trend line 1 confirms the recent retreat is a correction and not a significant change in the trend.

Think of it as a bear cub that was run over by an economic locomotive.

This rebound is part of a long-term sustainable uptrend which will move at a slower pace. A fall below the value of trend line 1 is more bearish, but potentially the beginning of a bear market. It indicates a strong but temporary trend reversal.

There is a very strong support trading band between 2,400 and 2,600. These are extreme downside targets. A fall below 2,400 confirms a grown-up bear. Traders will watch for a market rebound developing inside this trading band. The first resistance barrier is the value of trend line 1.

In the next week the market may dip below the value of trend line 1. If the market can close near to or above trend line 1 then traders will move aggressively into the market in anticipation of a return to up trending activity. The key feature to look for is the behavior of the long term GMMA. When this group begins to turn upwards it confirms investors are returning to the market as buyers.

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.

CNBC assumes no responsibility for any losses, damages or liability whatsoever suffered or incurred by any person, resulting from or attributable to the use of the information published on this site. User is using this information at his/her sole risk.

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