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Shanghai to Consolidate, Then Make 'Stairway' Gains

Have traders missed the China rally, or does this market still have powerful running legs?

The Shanghai Composite Index breakout from 2700 to above 3050 has developed consolidation behavior.

The upper consolidation band occurred in the October 2009-April 2010 period, where the index stayed in a broad sideways trading band of between 2950 and 3330. This is consolidation area 1 on the chart.

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The lower sideways consolidation pattern has support near 2580, and resistance near 2700. This developed briefly between May and June, and then again between July and September. This is consolidation area 2.

There is good support near 2950 so we are interested in the potential behavior in the area above 2950. The recent breakout above 2950 moved near to 3080 and then retreated, indicating there is a high probability the index rally and retreat between these two levels. Many traders will use this as a trading opportunity.

The next support resistance level is near 3180. This is also a recent support and resistance level. A breakout above 3080 has a resistance near 3180. This developed rally and retreat activity and a sideways movement in the past. Hence, a move above this level has strong historical resistance near 3330.

This series of recent support and resistance levels suggest the market uptrend may develop into a stairway pattern. This is a fast move up to resistance followed by a sideways pattern. Then the next breakout is also rapid, and develops another sideways pattern at a higher level. The stairway pattern usually develops over several months. Each new step takes several weeks to develop. The stairway pattern is a strong and reliable up trend pattern. Traders call this a stairway to heaven because it offers stable trend opportunities and good profits.

Traders remain alert for the development of trend reversal patterns in the Shanghai Index. The first suggestion of a large trend reversal is a move below support at 2950 with a short term downside target near 2800 or lower target near 2700.

The second pattern for a trend reversal is the development of a head and shoulder pattern. This is a low probability at the moment but traders will watch the development of rebounds from the 2950 support level.

Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders –www.guppytraders.com. He is a regular guest on CNBC's Asia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.

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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