Investors and traders in China have become rich over the last year trading Chinese stocks on margin. But the risk of trading Chinese stocks on margin was always that an overheated market would correct. Today there is officially a Chinese bear market as stocks on the Shanghai market have fallen more than twenty percent in the last two weeks. In 2011 we talked about how to buy Chinese stocks, sell and trade in a growing market. China has experienced growth in the last forty years similar to what the USA experienced in the decades after the Civil War. But as economies mature, growth tapers off. In the last year many Chinese real estate investors have pulled out of real estate at the bubble started to deflate. Many jumped into stocks and took advantage of very easy margin requirements to run up substantial gains. However, the risk of trading Chinese stocks on margin turned on many who were subjected to margin calls in the last days.
Chinese Stocks on Margin
We wrote about trading Chinese stocks on margin at the beginning of the year.
The benchmark Shanghai Composite index had its worst day yesterday since the market crash that ushered in the Great Recession. The Shanghai market has had an impressive run up in the last half year outdistancing the S&P 500. It turns out, however, that many traders with very little capital have been trading Chinese stocks on margin. The chickens came home to roost yesterday when securities regulators penalized three major brokers for allowing traders with insufficient capital to trade on margin. The result was an impressive drop of over more than 7 percent in Chinese stock market.
Anyone who was paying attention at the time would have taken more care as the Shanghai market resumed its climb. The risk of trading Chinese stocks on margin was that the Chinese economy and Chinese stock prices were disconnected and the market was doomed to fall and probably continue falling.
How Far and When Will the Market Rebound?
The problem when traders start getting margin call is that they need to sell out at lower and lower prices. What would have been a market correction becomes a market crash. Experts are expecting as much as a fifty percent drop in the price of stocks on the Shanghai exchange. However, despite slowing down the Chinese economy is still performing better than Europe or North America. One might expect that at some point the Chinese stock market will fall sufficiently that stocks will be fairly priced and even in the bargain range. At that magic moment the risk of trading Chinese stocks on margin goes away and it becomes a smart and lucrative process again.
Trading a Decline
When trading a Chinese stock decline the point is to successfully anticipate the point of a turnaround. Stock rallies come and go. Margin trading works great if you on the right side of a one way market. Beware of margin trading when things are too volatile and you are not sure of market direction.