SPIN A COIN on its edge and it remains stable for a while. Then, it begins to develop a wild wobble. The upper edge of the coin describes wider and wider arcs. This is a volatility wobble and it precedes the end of the spinning coin. The first volatility wobble in the Shanghai Composite Index appeared two weeks ago when the market dropped on July 29. This looks like a steady drop on the daily chart but, in fact, it was a dramatic sell-off that occurred in the last 20 minutes of trading.

 

The rapid rebound was also a warning of excessive enthusiasm. This is not the same as the infamous irrational exuberance. Excessive enthusiasm develops in a rising trend and creates a small bubble-environment, which is characterised by increases in intermittent volatility. It is a warning of trend weakness, but it is not a warning of trend change.

 

The degree of separation between the lower edge of the short-term Guppy Multiple Moving Average (GMMA) and the upper edge of the long-term GMMA has increased from around 60 points to nearly 120 points. This increase shows bubble pressure is developing. A market retreat that reduces the degree of separation to around 60 points indicates a sustainable and continuous uptrend.

 

The market is developing warning signals of a short-term trend retracement. The retracement could be limited to support near 3,300, or it could be larger and test support near 3,000.

 

There are two groups of features for traders to consider. The first group of features is the conditions, which show this is a temporary trend retracement, to be followed by a trend continuation. This is similar to the retracement in the US markets in early July. This temporary retreat may last for one to two weeks. The second group of features shows the conditions leading to a significant change in the trend, which may continue for between four and six weeks. This is still a temporary trend change as traders watch for a rebound from lower levels and a continuation of the longterm uptrend.

 

The first group of features for a temporary pullback uses the higher level support features. These are the upper edge of the long-term GMMA and the value of trend line 2. The lower edge of the long-term GMMA is near to the value of trend line 2. This is also near to the long-term historical support level at 3,000. A retreat to 3,000 is a fall of 13%, and this is within the range of a technical correction. The exact degree of the retreat is not important. The important feature is the ability of support to hold effectively.

 

A key leading indicator of support strength is the reaction within the long-term GMMA group of averages. These averages provide an indication of investors’ thinking. A wide separation shows investors remain buyers in the market. As the index falls, the investors buy securities at cheaper prices because they believe the price fall is temporary. If investors believe the price fall is serious, they become sellers. They sell to protect their profit. In this situation, the long-term GMMA develops compression.

 

The volatility dip on July 29 did not cause a compression in the long-term GMMA. A dip towards 3,000 will cause some compression in the long-term GMMA. A rapid compression warns of a more significant trend change. A small degree of compression confirms the temporary retreat in the index before a continuation of the uptrend.

 

The second group of features suggests a significant change in the trend. The most important of these is the Relative Strength Indicator (RSI). The development of a divergence pattern is a leading indication of a significant trend change. This RSI divergence was confirmed on July 30. A trend line on the RSI from July 2 to 30 is sloping down. The trend line on the index for this same period is sloping upwards. This difference in direction for the trend lines creates an RSI divergence. This divergence does not always mean a large trend change. The RSI divergence can also signal the temporary pullback to the 3,000 support level.

 

A fall below the 3,000 support level is very serious. The key support level is provided by the long-term uptrend line 1. The current value of this trend line is 2,800. This trend line has been tested several times. The most recent test was in March. This reduces the reliability of the trend line. It is possible the market may dip to this level and then rebound. The main historical support level is 2,900.

 

A temporary market retreat will bounce up from support in the area between 3,000 and 3,200. A larger market retreat will test support between 2,900 and 3,000 and has a possibility of testing the value of the long-term uptrend line near 2,900.

 

The most important indicator of a temporary retreat, or a larger retreat, is given by the behaviour of the long-term GMMA group of averages. This behaviour will be revealed in the next five to 10 trading days.

 

The same support considerations and analysis can be applied to the Greater China markets. Failure of a short-term rebound is a bearish signal for the Hang Seng and the Taiwan markets.