Enter The Dragon

Today I wanted to talk about developments that I am seeing in the Chinese Equity market, the Shanghai Composite and the A-Shares. I believe this also has an important read across for Australian equities and the Australian Dollar. 

The Shanghai Composite has been in a prolonged downtrend due to concerns regarding slowing economic development, a housing bubble, and a restructuring of the economy from an export driven model into a domestic demand driven model. Recently, the bearish sentiment has reached a fever pitch with front page articles detailing the collapse of steel prices and the imminent shutdown of Chinese mills. Such extreme sentiment often catches my attention as it provides an important backdrop for great trading opportunities. 

On Friday we saw a strong bullish reversal with the Shanghai Composite closing up +3% on news that the central government has approved 60 infrastructure projects totalling $150bn. I have done some further work and this turn appears right on a confluence of technical levels and a great support zone. Friday’s rally could be the beginning of a bigger picture bounce sequence and short covering rally. Could the market possibly be running up to the October change of government on the hopes of further stimulus measures and social programmes to come? This has a bullish read across for our resources sector and possibly even the AUD.

Let’s turn to the charts. On the whole, I do agree that fighting the trend is fraught with danger and clearly the bigger picture trend has been down in China. However, as traders there are times one can take advantage of possible trend exhaustion when price action confirms. These are low risk, high reward trade setups and traders need to be disciplined. Hopefully the charts below will demonstrate this more clearly

A-Shares Daily i:

Very strong bullish reversal candle and wide ranging day, with price breaking out of an ending wedge pattern. A wide ranging day is a day whose volatility significantly exceeds the average volatility of recent trading days. These have special significance after an extended decline and are often a signal of an upside trend reversal. 

A Shares Daily ii

I have shown examples in the past where we saw similar bullish reversal bars and a sizeable tradeable bounced ensued. Traders could use stops below Fridays low to play this bounce

A Shares Daily iii:

Note the bullish momentum divergences which form an important backdrop here. Despite price making lower lows, this is not being confirmed by the momentum indicator. This implies that momentum to the downside is waning and an end to the downtrend. Price is now testing key overhead resistance and any move above here should lead to increased short covering. 

A Shares Weekly:

There is a strong zone of support that comes in at 2150. This is the previous 2009 breakout level, a downward sloping trendline, and an A=C target off the high. 

A Shares Daily: Elliott Wave count

For the Elliotticians amongst you, I can clearly count 5 waves completed off the recent high. There is perfect alternation between Waves 2 and 4. Wave 3 was the strongest wave and the recent bullish divergences fit with the idea of this being the final Wave 5 down. This also implies a potential trend reversal to the upside. 

Any trading system must comprise the following components: the setup, the entry, the stop loss and the target. The setup has been clearly shown here. Traders could use breakouts above 2250 as a signal for a continued move higher with targets up to 2350. A stop loss could be used below Friday’s low offering a very good risk reward. 

I realise that many cannot play China directly through CFDs and futures. However, a bullish bounce in China will have a positive read across for our Resources and Energy Sector notably BHP, FMG,OZL,RIO, STO as well as all the smaller tier players. We have clearly seen the early stages of this in the last few days. Furthermore, a “risk on” scenario should be positive for AUD. Is this the catalyst that will take AUD out of its longer term triangle pattern and lead to a retest of 1.10 and beyond? Dont rule it out.

AUDUSD Weekly:

Triangle pattern with a breakout confirmed on a close above 1.06

Thanks

Austin