The Shanghai index is developing some of the characteristics of a trend reversal. The key feature investors were watching was the behavior of the index consolidation between 3,265 and 3,290. The 3,265 support level failed and the index rapidly moved to test the lower edge of the long term Guppy Multiple Moving Average indicator as a support level.
The significant feature now is that the lower edge of the long-term GMMA was successful in acting as a support level. That is a similar behavior to that following the market dip and rebound rally on July 17.
In the current situation, the long-term GMMA is more widely separated than it was on July 17. That suggests that the underlying uptrend is stronger and more resilient, which gives a stronger support base for a continuation of the rebound rally. That has two consequences.
The first consequence is that the strong base gives a bullish outlook because it is used for the next rally towards resistance near 3,265 and 3,290. The resistance forces in this resistance band are strong, so it is not surprising that the index will fail it the first attempt to breakout above that level.
A rally move into the narrow resistance band is bullish. A rally move above 3,290 is very bullish.
The second consequence is also related to the strength of the long-term GMMA support. If that support fails, then the market retreat will be severe. A sustained close below the value of the long-term GMMA has a downside target near 3,130. If the support level breaks, then the market can retreat very quickly. That's the main danger in the current situation.
The Shanghai index characteristic behavior includes days of substantial volatility. The market can dip and rally in very large movements. That is normal behavior.
The important feature in the market analysis is to consider its behavior in relation to the strength of the underlying trend. When the trend is strong, then the volatility dips provide a buying opportunity.
Investors watch for the index to move above the upper edge of the short-term GMMA. They also watch for the short-term GMMA to compress and move upwards because that shows traders have more confidence in the uptrend continuation.
The current index behavior shows a significant pullback and test of the uptrend. That is complicated because the pullback starts from the long-term resistance level that has created a triple top. However, a strong rally can develop into a successful breakout above the triple top pattern. Investors watch for evidence of developing momentum.
The Shanghai index is developing the characteristics of a trend reversal.
Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders, which can be found at www.guppytraders.com. He is a regular guest on CNBC Asia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe. He is a special consultant to AxiCorp.