Nasdaq-listed Chinese stocks have been subject to a wave of largely social-media based rumors alleging fraud, malpractice and accounting scandals. It has been effective in driving down the Nasdaq China market index and developing a classic shorting opportunity.
Accounting fraud is not restricted to Chinese companies. The Enron disaster continues to destroy many pension funds, as do the activities of Bernie Madoff. But somehow it seems more believable and more readily accepted if the allegations concern a Chinese company. At first glance at the Index the allegations seem to have power. Closer analysis suggests a different approach.
The behavior of the index can be described as a rapid recovery from the Global Financial Crisis lows, followed by an extended period of sideways movement. This sideways movement was broken with a well-defined breakout uptrend. The uptrend is easily defined with a single trend line, which has been decisively broken in the last two weeks. Wait a moment.
This behavioral description may be the Dow, the S&P, or the Nasdaq. The behavior of the Nasdaq China Index is not substantially different to the behavior of the broader indexes. Individual details may be different, but the broad pattern of behavior remains the same.
This suggests that trading strategies for the Nasdaq China Index are no different to those applied to the broader indexes. Despite the headline allegations, there are no substantial differences, or different opportunities, or risks, in this as a sector play.
These happen to be companies with a strong China focus, but they are traded with an American focus so the behavior of the index, and the stocks, has an American flavor.
This is an issue we have explored in more depth in relation to the co-listing of Chinese stocks in Hong Kong where the trend behavior diverges from the trend behavior of the parent stock in Shanghai. This clearly showed that price behavior is related to perceptions of value and not strongly related to the reality of company fundamentals.
The Nasdaq China Index is moving towards the upper edge of the historical trading band near 190. This is a well-defined support level. Aggressive traders will look for a rebound development from this level. The behavior of the Dow as it approaches support near 11,600 will provide guidance for the Nasdaq China Index behavior.
Failure of support near 190 sets a downside target based on the lower edge of the long term trading band. This is near 160. Again, this behavior is most likely to follow the behavior of the Dow if the Dow falls below 11,600.
There is one important difference with the Nasdaq China Index. Unlike the Dow it does not show an end-of-trend head and shoulder pattern. Unlike the broader Nasdaq, the Nasdaq China Index does not show a retreat from a long-term double top pattern. The Nasdaq China Index fall is a more ordinary move below an established uptrend line.
This is no special Chinese situation. The Nasdaq China Index does not move contrary to the broader market and nor does it lead the behavior of the broader market. Short side and long side opportunities are signaled at around the same time as they appear in the Dow. Traders may choose to execute strategies via the Nasdaq China Index as a personal preference, or because of better leverage. The Nasdaq China Index rebound has a potential 28 percent return compared with the 11 percent Dow return for the same behavior pattern.
Just as with any Index there are individual stocks within the index that have stock specific risks. These risks are identified with good technical analysis in the same way that the Enron collapse was not a “sudden and unexpected” result for even the most basic of technical analysis.
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.
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