Shanghai stocks are developing a classic pattern

The Shanghai composite index is developing a classic test and retest pattern that often precedes a major trend reversal. This is a pattern of behavior seen in the Guppy Multiple Moving Average indicator. It is a three-part pattern.

The first part is when a rally approaches the lower edge of the long-term GMMA and then retreats. That's a compression in the short-term GMMA and it happened Feb. 26.

The second part of the test pattern is a rebound rally that penetrates the long-term GMMA before retreating from this resistance feature. The short-term GMMA also turns up and touches the lower edger of the long-term GMMA. That rebound rally and retreat is currently developing.

The third part of the pattern is a new rebound rally that moves above the upper edge of the long-term GMMA before developing a new retreat that uses the long-term GMMA as a support level.

Usually the long-term GMMA is also turning up and developing some compression. The pattern is confirmed with a new rebound rally that takes the short-term GMMA above the long-term GMMA.

Sometimes there is a fourth test and retest retreat and rally before the new uptrend is confirmed.

The current retreat's first support feature is the upper edge of the trading consolidation band near 3,290.

The second support feature is the lower edge of the trading consolidation band near 3,260. A retreat to that level, and a rebound, would trigger an adjustment in the position of the up-sloping trend line. The index is currently testing that area as a support level.

The rally and retreat behavior is a good feature because it helps to establish a second anchor point for a new trend line. The retreat, and a future rebound are consistent with stable trend development.

There are two key resistance features for any rally rebound.

The first resistance feature is the upper edge of the long-term GMMA currently near 3,333.

Another resistance feature is near 3,440. That is the value of a long-term support and resistance level.

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.