With Chinese buying driving up the prices of everything from commodities to luxury goods, international equities could be next on the list. In theory, a fully liberalized China will mean that mainland Chinese would be able to buy stocks, futures and commodities all over the world and at the same time, allow everyone to buy directly into China’s domestic markets.
Beyond this new movement of capital, we can also expect a coming together of two seemingly very different trading styles – from the more institutionalized western trader on one side, to the more retail-driven, Chinese trader on the other.
But what will it take to succeed in this new market? Perhaps we should start preparing for higher levels of volatility, learn how the Chinese trade or possibly even consider taking those Mandarin lessons. We sat down with author,technical analyst and CNBC contributor Daryl Guppy, who has lectured and written extensively about the art and science of Chinese trading.
Q. You are well known for your keen interest in Chinese markets having published, “36 Strategies of the Chinese for Financial Traders,” where you draw on ancient Chinese wisdom. What are the key cultural differences between how the Chinese trade and traders in western markets?
There tends to be a misconception that Chinese traders are extremely retail-driven and their markets are much more volatile. In actual fact, Chinese markets are not any more volatile than western ones – in ratio terms they are the same when you look at their typical price retracements from peak to trough.
In my experience, Chinese traders tend to have a philosophical approach to investing. They are interested in the fundamentals and want to have a full understanding of the process. You have to remember they are generally investing with new wealth that has not passed through generations and before 2008, most had not really traded before.
Q. Yet Chinese markets have a reputation for being extremely retail driven. Is this a true reflection of reality?
While I agree there is more direct retail buying in China given its fund management industry is still in relative infancy, this does not necessarily mean it is more retail-oriented, than say the U.S. One reason for this is a lot of retail trade in the U.S. is now funnelled through Exchange Traded Funds (ETFs). This is effectively retail trading by proxy and it drives volatility. For example, if I buy an ETF and it comprises of four gold mining stocks and I later sell the ETF, this means the fund then has to sell four individual stocks. This also serves to increase volatility.
Q. Does China’s closed capital account have an impact on the level of volatility?
There is some evidence that China’s closed capital account is insulated from some of the volatility of global capital. For instance, we have seen how tapering has led to big moves in markets like Singapore, South Korea and India as foreign capital has exited, where you get massive flows in and out – but not in China. There is the risk that Chinese assets will be subject to more volatility as China liberalizes.
Q. Are there other regulatory measures that also restrict or impact trading in China?
Another feature of trading in China is it has a daily 10 percent limits on stocks, up or down. This can lead to more gapping behavior where stocks open with big changes from the previous close. This generally also means a less efficient market at price discovery.
China also does not allow intraday trading of stocks, which means it is not possible to engage in more speculative buying and selling within the same day. This means investors need to think very carefully about their entry and exit points.
Q. As China moves forward with various liberalization measures and opening its capital account – do you expect these restrictions will also be lifted?
I think China will do more to increase the efficiency of its markets such as allowing intra-day trading, shorting of stocks and more derivatives, but it is less clear whether this will be in the next 12 months, or two to three years. China is an “order driven” market and I do not expect it to become a duplicate of the U.S. “quote driven” market.
Q. How popular is technical analysis as an investment tool and is it used in the same way in China?
You can’t show me a chart and identify which country it is from. Price actions tend to be similar across all markets but there are differences in the significances of patterns versus some western markets. For example, there are differences in the interpretation, where some patterns such as RSI divergence are more reliable in China. Other patterns, such as parabolic trends – which are better for momentum trades have a tendency to occur more often in Chinese markets.
I think technical analysis is very popular both from the frequency of its use and the sophistication of how it is used. One problem that Chinese domestic equity markets have is in the availability of reliable market information to trade. Not only is the flow of information slower, it’s not always as reliable and not as transparent. This tends to lead to a greater emphasis on chart analysis than you might find in other markets.
Charts cannot be manipulated, even if they are driven by inside information.
Technical analysis can be used, irrespective of the underlying fundamentals of the stock. It can also provide indicators of when a market is being moved ahead of news. You can always look for this, it is a question of whether you want to trade with it or not.
Some of the technical analysis charting programs used in China are also more sophisticated than you see in the West. For instance, this can allow real time charting where automatic splits for shares and dividends happen real-time.
Q. Shanghai A-shares seem totally uncorrelated to mainstream equity markets. Do the charts give any hope that 2014 will be their year?
The Shanghai Composite Index has been having a great deal of trouble and has been in a basing pattern the past year. But it has been in an uptrend since September 2012, although it is struggling to regain uptrend momentum. In order to confirm its direction we need to see a close above 2,260.