A major inflection point for FXI: Is it time to buy? | “Filling the Gaps” with CMT

iShares China Large-Cap Exchange Traded Fund (FXI) holds 50 large Chinese stocks traded on the Hong Kong Exchange.

FXI could soon conduct a second test of the 2022 low. A successful test will show your strengths, while a failed test will show your weaknesses. Both outcomes can produce meaningful directional moves that provide a variety of trading opportunities. This is the kind of setup or point where I like to create an agnostic trading plan. Either way, I will have a trading and risk management plan in place to take advantage of either outcome.

From a macro perspective, I am optimistic as not much is happening in China. China is a command economy run by a communist regime in the process of retreating from capitalism. Importantly, leadership appears increasingly resistant to providing adequate fiscal stimulus. To that list you can add a rapidly aging population, a world increasingly resistant to purchasing goods, a rethinking of global supply lines, and serious raw materials and climate challenges. Of course, there are also positive aspects. They are becoming a microchip superpower and have made significant technological advancements over the past five years. I think the negatives far outweigh the positives.

My macro perspective informs my aggressiveness and risk tolerance. However, if the technical setup offers a clear risk-reward advantage, conflicting macro views will never hinder a trade. Technical settings are much more actionable than fundamental beliefs. And it is always good to remember that the more widely accepted a point of view is, the more likely it is that this will signal a reversal or reversal in the market.

Monthly Perspective on FXI

FXI’s monthly chart below shows some important technical developments.

Figure 1: Monthly chart of FXI.

Chart Summary:

• FXI is confined within the broader 13.43-50.80 range that has developed since the ETF began trading (four years after China joined the World Trade Organization (WTO)).
• In 2021, after rising slightly to the October 2007 highs, the market began a vicious decline (-60%). The decline from the February 2021 high was driven by increased trading volume and wide price spreads (suggesting strong selling). The movement was impulsive.
• In early 2022, FXI broke out of the broad ascending channel (AB, CD) that has defined most of its typical price movements over the past 15 years.
• The channel’s decline resulted in strong selling, but a temporary selling peak (red arrow) emerged as the market reached lateral support at 23:05 and opportunistic buying emerged.
• The minor climax followed the low of the broken channel and created a small automatic rally that quickly hit resistance. Afterwards, the market was weak for four months.
• This weakness was caused by wide price spreads and increased trading volume ahead of a potentially complicated Selling Climax (SC). SC looks complex from this perspective, but from an everyday perspective it looks more traditional.
• The automatic rally (AR) lasted four months and found resistance in the same 32-33.00 area that drove the market lower in March 2022.
• After testing resistance, FXI started to move back towards the sell high (19.81). During the most recent decline, the angle of decline was shallower than that of the larger decline (50.80-19.81) and volume was somewhat lighter. Shallower angles and lower volume mean there is less supply than in previous downtrends.
• The recent decline towards the October 2022 low could unfold as a second test. The results of that test are likely to lead to significant directional movement.
• Solid volume growth near recent lows (ST?) suggests strong buying, and a second test could be completed by the time the bulls hit.

Let’s go back to momentum.

FXI Monthly Momentum

Figure 2: Momentum of FXI. The MACD histogram has turned positive. A rise to the upper half of the Bollinger Band would be positive for FXI.Chart source: StockChartsACP. For educational purposes.Momentum Implications:

• Momentum is moving away from the price significantly and the Moving Average Convergence/Divergence Oscillator (MACD) histogram has turned positive. With this oscillator condition and trend, the strength of this position will be very positive.
• Prices have been confined to the lower Bollinger Band since July 2021. A rise to the top of the band would result in a major change in market character. The B-band is narrow. The narrow B band often appears right in front of a trend move.

FXI’s Weekly Perspective

After evaluating the monthly perspective, we will move on to the weekly perspective. I prefer to trade from this (weekly) perspective.

Figure 3. Weekly chart of FXI. If the ETF is well above its recent decline (AB) and volume and price spreads are widening, consider a bullish setup.Chart source: StockChartsACP. For educational purposes.

Chart Summary:

• The price/volume relationship is now more clearly depicted, detailed in a monthly perspective.
• False sell peak at A, complex peak at B, automatic rise to 32.36, low volume decline to point C (see shallow angle).
• Strong volume at point C suggests that strong hands are accumulating stocks near previous lows.
• Volume and price spreads decreased as the market rose from a low of 20.86. Although supply appears limited, demand remains tight. The potential for a setback to test 20.86 or even provide a more complete test of the 19.81 low remains good.
• In my opinion, it is too early to conclude that the second round of testing has been completed. However, if the market begins to move beyond the downtrend that defines a potential test (AB), especially if volume and price spreads widen, it is likely a sign that the test is complete. This allows you to utilize bullish setups with confidence.

FXI’s Daily Perspective

Figure 4. Daily chart of FXI. If you see bullish above the downtrend from A to B, it means FXI has bottomed. If FXI breaks above a downtrend channel, consider entering bullish flags and other corrective style drift patterns.Chart source: StockChartsACP. For educational purposes.A strength above AB indicates a good bottom. Above that level, bullish flags and other corrective style drift patterns can provide a good entry point.

Finally, we evaluate the daily perspective to ensure that larger price and volume characteristics are still maintained in detail.

• The initial sales climax (SC) stands out more clearly. Although the gap was significantly lower this day (opening much lower than the previous day’s closing price), it closed much closer to the day’s low.
• The lower bound drift (AB) is well defined, typically occurs at low volumes, and the test drawdown angle is shallow.
• I prefer a secondary test that is well separated in time and comes close to completely returning the climactic structure. This structure suits both aspects. I would prefer a deeper cut towards the 19.81 low, but 20.86 is close enough.
• As the market has rebounded over the past few weeks, trading volume has decreased noticeably and price spreads have narrowed. This is not ideal and indicates that the secondary test structure may be incomplete.
• A strength above AB indicates a good bottom. Above that level, bullish flags and other corrective style drift patterns can provide a good entry point.

Weekly relative strength ratio charts: China/Japan, China/World, China/India

Below is a monthly relative strength chart comparing FXI to iShares MSCI Japan ETF (EWJ), iShares MSCI World ETF (URTH), and iShares MSCI India ETF (INDA). China has consistently underperformed on all three. To be optimistic about anything beyond the trading turn, the Chinese market would need to strengthen significantly relative to the rest of the world.

Figure 5. FXI VX. EWJ, URTH and INDA. FXI has consistently underperformed EWJ, URTH and INDA. FXI needs to be strengthened compared to the others to paint a more optimistic picture.Chart source: StockChartsACP. For educational purposes.

MSCI Japan (EWJ) Monthly Outlook

Figure 6. EWJ monthly chart. EWJ is testing 2021 highs and FXI is testing important lows. If FXI is bullish and EWJ is bearish, you may want to consider a long-term spread trade.Chart source: StockChartsACP. For educational purposes.

The FXI:EWJ chart in Figure 5 is particularly interesting.

• As FXI is testing a significant low, EWJ is testing a 2021 high (see Figure 6).
• A potential divergence is appearing on the price chart for EWJ and the spread chart for FXI:EWJ.
• This sets up a potential long spread trade, especially if FXI shows signs of strength just as EWJ shows signs of weakness.

final step

The final step in my process is a sanity check. Am I falling victim to behavioral bias? Am I being cold-hearted? Is my belief system compromising my sense of fairness? In the case of FXI, we have to conclude that this may be the case. From a personal perspective, you may have reservations about investing in China. Historically, less liberal command economies tend to make poor investments. Additionally, phasing capabilities may change due to policy changes and risk management overlays. My strong opinions can get in the way of reading FXI charts. Because of this, I will have to pay more attention than usual to how I create my trading plan.

memo: Many of the topics and techniques discussed in this blog post are part of the CMT Institute’s Certified Market Technician curriculum.

Shared content and published charts are for informational and educational purposes only. CMT Association does not provide this information, and this information should not be understood or construed as financial advice or investment recommendations. The information provided is not a substitute for the advice of an investment professional. CMT Association will not be liable for any financial loss or damage that may occur to the audience.