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Strong chance of a rally in Chinese stocks

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Dan Kitwood | Getty Images

The Shanghai Index has developed a strong breakout above the resistance level near 3000 with a upside target near 3400. The short-term group of averages in the Guppy Multiple Moving Average (GMMA) indicator has moved above the upper edge of the long-term GMMA.

This is bullish. A strong uptrend breakout is signaled when the lower edge of the short-term GMMA moves above the upper edge of the long-term GMMA.

The long-term GMMA degree of compression has shrunk to 39 index points compared with 69 index points last week. This shows investors are increasingly more confident about the sustainability of the new uptrend. This increasing rate of compression in the long-term GMMA means a strong rally has more chance to develop because investors are more confident and they will also participate in the rally. This combination of factors helps to accelerate the trend change.

The classic GMMA pattern of bullish test and re-test behavior is often associated with the change from a downtrend to a new uptrend. There are four parts in this Shanghai Index pattern .

The first and second part are when the short-term GMMA compresses, turns upwards, touches the lower edge of the long-term GMMA and then retreats. This pattern test and retest has already happened twice.

The third part is when the short-term GMMA again compresses, turns upwards, penetrates the long-term GMMA and uses the upper edge of the long-term GMMA as a resistance level. This has happened. The short-term GMMA then retreats again. In this part of the pattern development, the long-term GMMA also begins to compress. This part of the pattern is currently developing and now traders wait for a breakout above resistance near 3000. This has happened.

The final part of the pattern is when the short-term GMMA compresses and develops a new rally rebound that moves above the value of the upper edge of the long-term GMMA. After the breakout, the short-term GMMA retreats and investors should use the upper edge of the long term GMMA as a support level.