In overnight trading the Australia 200 Index hit a new high for 2012. While the post-GFC proliferation of "false breaks" and overbought oscillators suggest caution, the primary evidence points to further gains before year end.

The potential for a "Santa Claus rally" was highlighted in late November. However, the speed of the rally caused concern - it appeared a correction was on the cards. The shallowness of the correction (circled on the chart below) points to real underlying demand for Australian shares:

Australia 200 - Daily

20121212 xjo

Source: CMC Tracker

The move through the 2012 high is a classic "break out" - suggesting further gains despite the height and speed of the rally so far. Traders who watch mean reversion based indicators (RSI, Stochastics, Bollinger Bands) are likely to have concerns about overbought readings. Nonetheless, I'm going with the price action for a number of reasons.

Short and medium term trends are clearly pointing upward. The move through 4,585 not only sets a new 2012 high, it breaks the index out of a 15 month trading range. Price/Earnings ratios are higher (around 18x) but the all important dividend yield at 4.55% (plus franking credits) remains well above cash rates.

Beneath the surface of the index, the last few days saw a change of leadership of the market. The first part of the rally was driven largely by yielding stocks (updated yields for Telstra and the big 4 banks here). However, data from China over the weekend meant the baton has passed to the resource stocks. With a stronger investment case for resource and finance stocks (around two thirds of the index) there is a fundamental case for further gains.

And from a trading point of view, the clear break out level gives an attractive reward/risk ratio. here's my trade:

BUY Australia 200 Index at current prices, stop loss below 4,580,

targets 4,620 and 4,665