The Chinese stock market has been volatile over the past few weeks. I have been monitoring this chart over the past few months. What I am about to tell you is that we’re experiencing the end of one of the best stock market rallies in the world.
Over the past few weeks, the Chinese stock market proved to be extremely volatile. Sadly, on Monday, June 29th, the Shanghai Composite Index tumbled by more than five percent. Investors may or may not be enjoying the rollercoaster ride of the Chinese stock market over the past few weeks.
The Shenzhen Stock Composite Index is one of the most volatile markets in the world. The index includes many new technological firms that gave it its extreme volatility.
Take a look at this daily chart of the Shenzhen Stock Exchange Composite Index.
Courtesy of www.Stockchart.com
Let’s take a closer look:
I am going to explain a phenomenon pertaining to a technical analysis of the stock market; a Bump and Run Reversal. As the name implies, the Bump and Run Reversal is a reversal pattern that appears after excessive speculation that causes prices to go up too fast.
There are three major phases in this pattern:
1. Lead-In (Blue Line)
It’s the initial pattern that forms the trend line, which could last one month or more. There is no speculation and prices are supposed to go up in an orderly manner. The trend line is supposed to be moderately steep and steady. The index was supposed to grow at a steady level of about 20% to 25%. The growth would have rewarded the investors at a remarkable rate higher than many other indices.
2. Bump Phase (Green Line)
Here is where a Chinese bull market transforms into a full-blown stock market bubble. The bump forms with a sharp advance and prices move further away from the lead-in line. Clearly, investors’ speculation would inflate the prices and cause the angle between the green line and blue line to widen.
3. Bump Rollover (Red Line)
Investors know that the speculation will die sooner or later. When that happens, prices begin to decline towards the lead-in trend line, and the right side of the bump forms.
The sad part comes after the trend line is broken. Chinese stock prices have little support until they hit the 500 level—nearly 30% lower from today’s current price.
For investors, the sharp increases would cause assets to be priced beyond their fundamentals. Consequently, inflating asset prices drove the index into bubble territory. Many investors witnessed the same phenomenon in the financial crisis of 2008, and the dot-com bubble of early 2000. All told, this story, too, could be the beginning of the bursting of another asset pricing bubble.