Charts: Keep cheering, China stocks to rise further

Shanghai Stock Exchange
Carlos Barria | Reuters

The Shanghai Composite has rallied sharply this year, outperforming its regional peers in the first quarter, and charts suggest further upside is likely.

China's benchmark stock index has risen 17 percent year-to-date, spurred by easing measures from the People's Bank of China and buying among local retail investors. The gains follow last year's stellar performance, but have led some investors to question whether the index has risen too fast.

The Shanghai Composite quickly reached the 3800 target level thatwe projected at the beginning of March. This is above the long-term historical resistance level near 3750, which suggests a high probability that the index will consolidate near the 3750 to 3800 level. This type of pause in the fast uptrend is bullish; it creates the foundation for a continuation of the uptrend.

There are three bullish features for the trend that are shown by the Guppy Multiple Moving Average (GMMA) indicator.

The first is the degree of separation on the short-term group of averages in blue, which shows what traders are thinking. The wide separation suggests they are bullish, aggressive buyers.

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We see the same feature in the long-term group of averages in red. The consistent wide separation is evidence of strong investor buying support for the trend. When the market pulled back in March the long-term group did not compress, which indicates strong buying support.

The third feature is the consistent degree of separation between the long-term and the short-term group of averages – a feature of a strong and stable trend.

We used the support and resistance band between 3000 and 3400 to set the upside target for the trend breakout earlier this month. We use the same method to set the next upside target for the breakout above 3800. This target level is 4200. This is a technically-calculated target and must be verified against the historical activity of the index using a monthly chart.

On the monthly chart the historical support level is near 4350. This suggests the market can move above the technical target near 4200.

The danger in the fast up move comes from the threat of a strong trend correction. Investors should watch carefully for the development of end-of-trend chart patterns including a head and shoulder pattern and rounding-top patterns.

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