We asked traders if the Chinese stock market will crash

July 31, 2015 03:00 PM

Al Brooks

For me to call the selloff a crash, I would need to see another comparably strong leg down, and that is unlikely.

I always think in terms of probabilities, and since crashes are rare, the selloff in the Chinese stock market probably will not result in a crash. The monthly chart has had a strong bear reversal. The selloff has been strong enough so that the best the bulls can reasonably hope for over the next 6 months is a trading range.

The monthly chart of the Dow Jones Shanghai Index had a strong bear reversal, but it is still above the top of the 2009 to 2010 trading range.

Bulls who bought higher will use any rally to exit longs. Bears who are not yet short will also use that rally as an opportunity to sell, betting that the first reversal up is unlikely to result in a resumption of the bull trend. Instead, it is more likely to be followed by at least a small second leg down and at least a trading range.

It is also possible that there might be a dip below the top of the 2009 to 2010 trading range on the monthly chart. However, the downside will probably also be limited and the result will most likely be a trading range for a year or more. The market will have to probe up and down to determine the top and bottom of the range.

The daily chart of the Dow Jones Shanghai Index had a strong bear reversal, and a test of the low of the breakout. The bears are hoping for a double bottom and at least a trading range. The bulls are hoping for a channel down.

After the market has been in a trading range for 20 or more bars on any time frame chart, bulls will begin to see buy setups. Bears will continue to see sell setups. The market will then be in breakout mode and the probability for the bulls will get about as high as it is for the bears. The bulls will look for a measured move up and the bears will look for a measured move down. Most traders will wait for the breakout to see if it is strong. If it is, they will enter in the direction of the breakout. If it is weak, they will look for a setup that will allow them to enter in the other direction as the breakout reverses.

Al Brooks, M.D., is author of the 36 hour Brooks Trading Course, several books on Price action (Reading Price Charts Bar by Bar, Wiley, 2009, and the 500,000 word, three-book series, Trading Price Action, Wiley, 2012), and numerous articles in Futures Magazine. His trading course is available at www.BrooksTradingCourse.com, and he provides live intraday E-mini price action analysis in his trading room and free end-of-day analysis at www.brookspriceaction.com.
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