Top Advisors Corner

Vipul Ramaiya: China: Hammering a Major Bottom

Vipul Ramaiya

Vipul Ramaiya


A Wyckoff Spring occurs when an instrument falls below a clearly defined trading range (particularly a closely monitored support shelf), makes a new “panic bottom” (maybe indicated by a huge lower shadow in a candle chart) — and then “springs” back or recaptures the violated support level. This pattern is normally spotted in the “Accumulation” phase of the market cycle, and offers a superior risk/reward trade opportunity. 


As shown in the chart, we are looking at a major bottom formation in the Chinese Shanghai Composite Index. The index is basing out near its 2009 bottom, and successfully retested the lower end of a consolidation range. Investor sentiment is at multi-year lows, and very few data points suggest economic stabilization at this juncture. However, the stock market is forward looking and price is always the first to move, meaningfully before the economic data starts improving. 

Outperformance/underperformance is nothing but a cycle, it keeps rotating. Markets and sectors that are not faring well today, will bottom out and lead in the future for a period of time. Technical analysis is one of the most effective disciplines that helps you isolate, identify and profit from these rotations, and un-complicating the process at the same time. Research suggests that most investors act based on sentiment, not their methodology. The fear of being left out overtakes all logic, and even the best of the value investors will commit funds to long positions at the worst possible moment (read: all-time highs for the last time!). We are witnessing a similar phase in the Shanghai index, but exactly in reverse. Sentiment is clearly negative and is near multi-year lows, and this probably is one of the very few indexes to have missed out on the global equity rally over the last couple of years. Let’s take a closer look at some performance charts that highlight an important cycle from a historical perspective.
 

Similar phase: 
•    2003-05 (sharp underperformance to the Asian peers)

·         2005-07 (The next 3 years: solid outperformance)

·         2012-Present Day (Stark underperformance over the last 2 years, flat 5-year returns)

As technical analysts, we deal with probabilities and not possibilities. This is just one of the many trading opportunities in the market today. As traders, our only objective is to identify trades that have a higher probability (read edge / positive expectancy) of generating positive net returns over a large sample, and the Shanghai Composite index presents an excellent opportunity at this juncture. If proven wrong, the potential downside (stop-loss) could be approximately 10%. However, should the trade work in your favor, a quick jump (in the next 2-3 months) to the ’12 highs – 2,450 cannot be ruled out. I believe that the upside potential is significantly higher; maybe even the 2009 highs over the next several quarters. 
For those who are already long, size your stop-losses appropriately to provide sufficient breathing space for the trade to unfold. On the other hand, those looking to get into a long trade here may have to wait for a few trading sessions and enter on a 2-3 day pullback/consolidation for a favorable risk/reward. Lastly, traders short on this market may need to reconsider their stand, as reversals from Wyckoff springs are normally quick and are backed by strong upside momentum.
 

Price objective: 
•    2-3 months: 2,450
•    1 Year: 3,000 (size of the base projected upwards)

End note: I believe objectives based on price patterns will always be exceeded. These are useful from a couple of perspectives: 1) keeping yourself aligned with the primary price trend and ignoring short-term noise; and 2) using these price objectives to take partial profits. 

Vipul Ramaiya, CMT