The underlying trend strength and comparatively reduced volatility sends a bullish message to the greater China markets. However, volatility returned last Friday with a sudden test of support at the lower edge of the short-term Guppy Multiple Moving Average (GMMA). The initial lack of strong bearish reaction to the China trade and investment figures provided support for the Hang Seng Index, particularly the red-chip component. Upside targets near 21,000 for the Hang Seng are more achievable as it hitches a ride with the China economy. Although the Taiex pulled back, the strong support near 6,300 suggests a higher probability of a rebound and retest of 7,000, based on the continuation of the Shanghai bull trend.

 

It was never expected that the Shanghai Index’s move from 2,600 to resistance near 2,900 to 3,000 would be smooth. A pause in momentum developed last week, creating a short-term resistance level near 2,790. The lower edge of this resistance area was near 2,740. This is a pause in the upward momentum and it’s useful because it provides a potential support area for any retreat as the index moves towards 2,900.

 

This is a strong and steady uptrend, but it cannot continue to move only in one direction. There will be retreats within the environment of the trend. This happened in April and May and the retreats seem to occur every four or five weeks. Traders will be alert for a repeat of this retreat activity in the coming two weeks. Friday’s retreat may be an early start to this pattern.

 

A retreat that touches the upper edge of the long-term GMMA and then rebounds is consistent with the long-term uptrend. These retreat and rebound points provide a good entry opportunity for short-term trades. They provide an opportunity to add to existing investment positions.

 

Traders can explore the lagging relationships between these Shanghai Index retreats and the pullback behaviour in the Hang Seng and Taiwan markets. This provides entry opportunities for index and exchange-traded fund traders.

 

As the uptrend develops, it is important to look at indicators that may suggest its temporary end. These indicators warn of a more significant trend change. Think of it as a stress test. This type of change has a high probability of developing a temporary downtrend and it has a strong impact on open profits. Many traders aim to exit the trend before these larger trend changes develop and then re-enter the trend when the long upterm rebound develops.

 

Defensive traders watch the Relative Strength Indicator and use it to give warning of a significant trend change. It is applied as a trend stress test. The key feature is the development of the RSI divergence pattern. A trend line is placed along the peak points of the rallies in the index. This is currently an upsloping trend line. Another trend line is placed along the peak points in the RSI indicator. If this trend line slopes in the opposite direction to the line of the index chart, then we see the RSI divergence. This is a leading signal of a trend change. Currently, there is no divergence signal. The RSI confirms the uptrend continuation. RSI divergence is a leading signal of trend reversal, so traders will be alert for this development, particularly as the index moves towards resistance between 2,900 and 3,000.

 

Another reliable leading indicator of trend reversal is the development of reversal chart patterns. These patterns include short-term head-and-shoulder patterns and rounding tops. Neither of these patterns is currently developing, but traders need to be alert for any development in the future. A potential shortterm head-and-shoulder pattern could develop as the market reacts away from the 2,900- to-3,000 resistance.

 

Technical indicators such as MACD, Stochastic and Williams %R do not provide good analysis tools for assessing long-term trend continuity and stability.

 

Traders are also alert for a bubble development, when the short-term uptrend moves a long distance above the long-term uptrend. This rise usually includes an increase in volatility. When the short-term trend collapses, it falls a long distance before it hits the next support level, and often temporarily breaks through the support level. A very fast rise towards 2,900 could create this type of bubble, so the reduction in momentum this week has been good for trend stability.