China's stock markets are known for their volatility and not for the faint-hearted investors. Their movements can be rapid in either direction and hard to predict. But a close study of their performance charts have revealed some trading opportunities and the likelihood of a strong recovery.
The key Shanghai Composite indexfor instance, which fell 22 percent so far this year, continues to develop a classic breakout consolidation pattern. This includes a retest of the support area near 2,481, creating a double bottom which is often a signal for strong recovery.
This type of rebound, retreat and retest of significant support area is often associated with the development of strong new trend breakouts. This breakout is signaled with a sustained move above 2,680.
The nearest strong historical support level is at 2,300. This creates the probability that the market may make a temporary and rapid fall to this level and then quickly rebound. A fall below 2,481 followed by a fast rebound above 2,481 is a buying signal - also called a desperation sell-off - identified by the speed of the rebound and by the volume behavior.
The development of a fan pattern of trend lines is also a leading indication of market reversal. This is a strong feature of Shanghai market behavior, which preceded the market reversals in 2008 and 2005.
There is a strong probability the market will temporarily dip towards the historical support at 2,300 and then rapidly rebound. This dip could develop as a one-day fall or rebound, or a three-day pattern.
The key features confirming the temporary nature of this dip is the reduction in volume as the market falls and the increase in buying volume as the index rebounds.
A rapid dip below the 2,481 level does not invalidate the development of the consolidation pattern between 2,481 and 2,680.
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.
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