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Chinese Strategies That Reel in the Prize Fish

The firestorm turmoil up by the failure of the Chinalco/Rio Tinto deal and the subsequent rapprochement between bitter rivals, BHP Billiton and Rio have the makings of a TV mini-series drama. It's enthralling viewing, but many observers are missing the vital sub-plot which leads to the surprise ending.

In photo released by Sundream Motion Pictures on Thursday, Nov. 23, 2006, shows a scene from the movie " Battle of Wits ." ( AP Photo/ Sundream Motion Pictures) ** NO ARCHIVES EDITORIAL USE ONLY **
AP
In photo released by Sundream Motion Pictures on Thursday, Nov. 23, 2006, shows a scene from the movie " Battle of Wits ." ( AP Photo/ Sundream Motion Pictures) ** NO ARCHIVES EDITORIAL USE ONLY **

This is not a lovers triangle. The drama is closer to the Chinese film, The Battle of Red Cliff, where viewers watch the interplay of the 36 strategies of the Chinese.

There are three of the 36 strategies combined in the current screenplay. The first is called, making a feint to the East while hitting out in the West. The second, catching a fish in troubled water. Finally, the third is called killing with a borrowed knife. These are strategies of opportunity and they are quickly applied.

There is nothing quite like headlines to grab and divert attention. The headlines were not planned but they provide an opportunity to making a feint to the East while hitting out in the West.

The bluster created by the Chinese Government, the steel mills association and others players, creates a sense of obligation in the Australian government. There is increasing pressure to demonstrate that the Chinaclo/Rio deal foundered on commercial reefs rather than on the drawn out process of the Australian Foreign Investment Review Board process and the populist opposition raised by some politicians. The important result is that the flow of Chinese investment capital is not blocked. It is simply diverted.

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This moral pressure creates the opportunity to catch a fish in troubled water. The political turbulence makes it easier to speed up the approvals process for other deals, such as the OZ Minerals bailout. There are plenty of other fish to be caught in these muddy waters. Some are minnows with nothing other than exploration licenses. The potential that Chinese capital can have, is a dramatic impact on market prices.

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Others would be fish, I mean companies, such as Fortescue Metals Group, are larger second tier companies with established iron ore reserves. The market belief is that these second tier companies will now benefit from Chinese capital, and this provides trading opportunities with returns of near 100 percent in as little as five days.

This is news and rumor based trading. It brings with it a particular set of risks which include a fast run-up and an even more rapid decline in price. The chart pattern that captures this opportunity, and its consequences is the parabolic trend line. This is a curved trend line that rapidly moves towards becoming vertical.

The very useful aspect of the parabolic trend is the way it is used to calculate an end date for the rising trend. Once set, the position of the trend line does not change. As each new trading day is added the candle display moves closer to the trend line. There comes a date when the next candle will inevitably move to the right of the trend line and trigger an exit signal.

The parabolic trend line captures momentum and excess so the usual result of a break below the trend line is a very rapid collapse of prices, often in the range of a 50 to 70 percent retracement in two to four days. There is nothing quite like the feeling of watching profits evaporate rapidly. Traders use the parabolic trend line pattern to develop exit strategies which capture the rapid profits available.

Many commentators are focused on the fallout from the collapse of the Chinalco/Rio deal and the creation of a duopoly in the iron ore market with BHP/Rio. Traders are focussed on the opportunities created by the diversion of Chinese capital into second tier companies. These traders will use the strategy of killing with a borrowed knife. In their case, it's a Chinese knife that has created the opportunity to make a financial killing and shows it's not just the Chinese who can benefit from these strategies.

Daryl Guppy is also the author of 'The 36 Strategies of the Chinese for Financial Traders'.

If you would like Daryl to chart a specific stock, commodity or currency, please write to us at ChartingAsia@cnbc.com. We welcome all questions, comments and requests.

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