Chinese stocks break a two-decade trend, and that could signal more downside

The Chinese stock market is getting wiped out.

China's Shanghai Composite sank to four-year lows this week, while the so-called BATS stocks — Baidu, Alibaba, Tencent and Sina — have suffered heavy losses this month.

That tsunami of selling has inflicted heavy technical damage on the Shanghai Composite, says one technician.

"There's been a very long-term uptrend that's been intact since 1996, and the recent price action on the Shanghai Composite is now violating this," Craig Johnson, chief market technician at Piper Jaffray, said on "Trading Nation" on Thursday.

"From a technical perspective, the next area of support that would come into play on the Shanghai Composite would be around 2,000. That's about 20 percent lower from here, so still significant downside left to go," said Johnson.

As of Thursday's close, the Shanghai was 30 percent below its 52-week high, pushing it deep into a bear market. Another 20 percent drop would drag it 44 percent from the year's highs. It rose 2.58 percent on Friday, even though China's latest GDP report was lower than expected.

"Are you going to continue to see the Shanghai come down, [and] will that ultimately affect the U.S. equities? From my perspective I think the answer is ultimately yes it will," said Johnson.

So far, the S&P 500 has mostly resisted the severity of sell-offs seen in Chinese stocks. The index is down 5 percent this month, around half the drop on the Shanghai Composite. The FXI China large-cap ETF has fallen nearly 10 percent.

There is one Chinese tech name that could be worth a second look, according to Stacey Gilbert, market strategist at Susquehanna.

"Alibaba would be the name that I would highlight," Gilbert said on "Trading Nation" on Thursday. "China has huge and growing e-commerce, and we believe that this is going to be the winner, Alibaba will win. There's no doubt about that."

Alibaba posted 60 percent sales growth in its most recent March-ended fiscal year. It has reported double-digit revenue increases for every year since its U.S. market debut in 2014.

"There are two ways you could play it," Gilbert said. "Set it and forget, just buy the stock, don't look at it again. … The alternative is buying calls."

Gilbert says an in-the-money call in Alibaba shares would provide upside exposure while limiting downside risk. Although elevated volatility has made it more expensive, Gilbert says it is not elevated relative to ETFs that contain the stock.

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Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's “Closing Bell (M-F, 3PM-5PM ET).   In addition, he contributes to CNBCand CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

Follow Michael Santoli on Twitter @michaelsantoli

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