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(Interview) Chinese Stocks: Here Comes the "Boom"
New Shanghai Composite insights from Elliott Wave International’s Intraday Asian Stocks Analyst
In this new interview, our Intraday Asian Stocks Analyst, Matthew Gress, tells you what Monday’s (July 27) sharp decline in the Shanghai Composite means for the index going forward.
******** Alexandra Lienhard: Matthew, the Shanghai Composite just fell 8.5% in a single day. Last Thursday (July 23), you emailed an alert to several people here at the office saying that the "ABC rally from the recent lows nears a conclusion" in Chinese stocks. In other words, you expected this rally to end. Why? Could you explain what made you suspicious of the rally?
Matthew Gress: Hi Alex. As I mentioned in our previous interview (read here), before the recent rally began, the Elliott wave pattern in the Shanghai Composite’s charts had already called for it. When it started, we knew it would most likely develop as a 3-wave, corrective move. We’ve been watching the rally develop, and last week it satisfied our minimum upside expectations when Chinese stocks rose above 4035.
What’s more, the final push lacked strong upside momentum, and the entire bounce from the 3374 low took on a corrective, three-wave appearance (partial Elliott wave labels shown -- ed.):
Therefore, the focus shifted toward signs of a bearish reversal.
Alexandra: What Elliott wave pattern is the Shanghai Composite tracing out now, after Monday's sell-off? And what does that imply for the trend over the next few days?
Matthew: The ABC rally you see in the chart above is probably only the second leg of a larger correction. If our interpretation is correct, the index has further to fall. We have to reserve the actual price targets for subscribers, you understand, but suffice it to say that the risk is to the downside.
Alexandra: You mentioned “risk” -- how do you use the Wave Principle to limit risk?
Matthew: When I first look at a chart, I try to identify which parts of the price pattern look corrective (i.e., developing in three waves) versus impulsive (i.e., developing in five waves). Is the price in a choppy and corrective range, or does it show notably long price bars in an impulsive wave form? It’s really as simple as that; that's you basic visual assessment. Then, I proceed with placing the appropriate Elliott wave labels on the chart: "1-2-3-4-5" for impulses and "ABC" for corrections (as you see in the chart above). At this point, you can start talking about risk-management.
One way to limit risk is to make sure that the wave pattern that you think is unfolding actually follows the rules of Elliott. For example, one rule says that wave two cannot retrace more than 100% of wave one. So, if you are tracking what you think are waves 1 and 2, looking to jump in for the third wave rally, then the start of wave 1 is the point where you know your "1-2" wave count is wrong:
And there's your “risk.” If wave two retraces the entire length of wave one, then it's not a wave two, and it's time get out.
This is the beauty of Elliott. We are not grinding out "market fundamentals." Instead, we look for one pattern to end -- and another one to begin. That gives you both price targets and levels where to place your stops, for risk-management.
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