Get 40% Off
🤯 This Tech Portfolio is up 29% YTD! Join Now to Get April’s Top PicksGet The Picks – Just 99 USD

Why The Volatility In Shanghai?

Published 08/05/2017, 12:17 pm
Updated 09/07/2023, 08:32 pm

Originally published by guppytraders.com

Why does the Shanghai market rise and fall so rapidly? It’s a question I have been asked many times in the past week in the face of the rapid fall in the Shanghai Index.

The standard explanation is that the Chinese market is dominated by retail traders and they cannot be trusted. It's they who are responsible for the rapid falls.

This idea is patent nonsense.

The average holding period for stocks on the New York Stock Exchange is less than 1 second and this is an exchange dominated by institutional and fund managers, not excitable retail traders. In 2008 these same fund managers were the ones busy selling their investments while, at the same time, telling their clients not to panic and not to sell. This is clear from the composition of the volume sales on the first days of the 2008 falls.

The explanation for Shanghai market volatility lies elsewhere. There are four structural factors which contribute to the accelerated rises and galls in the Shanghai market.

The first is the limit up limit down restrictions. When the price move reaches 10%, trading is halted until the next day. Image you are a seller. You want to get out at 100, but the stock is locked limit down at 100 and your order is not filled. The rational reaction is on the next day to offer to sell at a lower price, say 98, to make sure you get out before price locks limit down again.

The reverse applies in a rising market as buyers bid higher to get stock before it locks limit up. The result is both up and down trends accelerated unnecessarily.

The second explanation is the ban on short sales. This means the market can only be traded form the long side. In a falling market the options are to sell quickly – adding to the cascade effect of selling. Or to simply sit on a loss. There is only one rational course of action, and this contributes to an acceleration in the wave of selling.

The third explanation is the ban on intraday trading. Stock you buy today cannot be sold until tomorrow. This has the effect of widening the stops so the move downwards is not slowed by incremental selling. Instead the selling on stop is concentrated on the day following the initial fall. Again this accelerates the downtrend.

The final factor is the lack of derivative markets which can be sued to hedge a falling market. This leaves investors with few alternatives in a falling market. Selling is the rational thing to do and when everybody has only this choice then naturally the market fall is amplified. This is not a sign of irrationality, but a sign of extreme rational thinking.

These are structural factors that impact the Shanghai market. In this environment the key focus is on the strength of support levels in the Shanghai Index. Traders watch for consolidation support to develop near 3070. Once support is confirmed then they will enter the market as buyers.

Chart

Daryl Guppy is a leading international financial technical analysis expert and special consultant to Axicorp. Guppy appears regularly on CNBC Asia and is known as "The Chart Man". Disclaimer: Daryl Guppy is not a financial advisor. These notes are for educational purposes only and provide an example of applied technical analysis.

Latest comments

Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2024 - Fusion Media Limited. All Rights Reserved.