SINGAPORE (Feb 12): A funny thing happened in markets the past week. The US market, dominated by institutional and fund traders and supposedly the model of restraint and stability, staged a nerve-racking plunge.
The China market, dominated by mum-and-dad retail traders and supposedly a model of unrestrained volatility, did much the same, but this was a continuation of an already-retreating market.
The similarities go to the heart of our financial system. It dispels the myth that the Chinese retail-dominated market is inherently more unstable and volatile than the US one because mum-and-dad investors are more emotional than the “mature” US fund managers. Dispelling this myth is important because it allows us to evaluate the Chinese market more objectively.
The claim is that the key difference between the two markets is the influence of fund managers and the development of trading instruments and techniques that have been lauded as modern in contrast to China’s less-mature market.
The first difference is the exchange-traded fund (ETF) industry, followed by its nasty cousin, high-frequency trading (HFT) and then by the dominant role of fund management institutional money.
Here’s an important contradiction. Commentators and fund managers interviewed on CNBC and Channel News Asia all said “Don’t panic. Now is not the time to sell”. Soothing advice, but advice that did not reflect the reality of the situation.
The selldown in US markets was characterised by high-volume block trades. This type of trades is the sole preserve of the funds and financial institutions. At the same time that these industry players were saying “don’t sell”, the prevalence of block trades shows they were busy selling as quickly as they could. China’s mums and dads showed the same behaviour as US fund managers.
Enter the ETFs. ETF activity in the US markets accounts for more than 50% of trading activity on any given day. The momentum of the fall was accelerated by ETF redemption selling and rebalancing. This is massive institutional trading activity and creates a tsunami of selling.
The ETF market in China is much smaller and plays a minor role in China trading activity. However, the aggregate role of Chinese retail investors creates a market behaviour that is no different from that seen in the US with ETF fund redemptions. Both groups panicked to a similar degree.
In the US, these increased institutional and ETF trading volumes attract market parasites — the high-frequency traders. They need very high volumes to be able to trade effectively. Their frenetic trading activity makes it more difficult for the market to develop consolidation. HFT exaggerates the degree, or extent of the fall, pulling the market down with thousands of ill-considered bites.
In China, the ban on intraday trading and short-selling delivers a similar effect. The fall cannot be arrested by short-selling, so investors have no choice but to offer to sell at ever-lower prices. Falls are accelerated as investors are unable to find buyers.
It turns out that the wisdom of China’s retail investors and the reactions of US fund managers are not so different after all.
Technical outlook for the Shanghai market
The defining feature of the Shanghai Index retreat is the failure of support areas to act as consolidation points for the fall. This is bad news for investors who anticipated consolidation in these areas and the potential for a rebound rally to develop.
It is good news for the development of any future rebound rally because it suggests that these old support levels will not act as strong resistance levels. This makes it easier for a new uptrend to develop.
Three key support features were broken. The first was a combination of features near 3,440. This is the value of a long-term, support-and-resistance level. It is also near to the value of the upper edge of the long-term group of moving averages in the Guppy Multiple Moving Average (GMMA) indicator. The Shanghai index did pause temporarily in this area.
The second support feature is the lower edge of the long-term GMMA. The wide separation in the long-term GMMA acted as an airbag to cushion and absorb the initial market retreat. However, it was not strong enough to absorb all of the selling pressure that developed on Feb 6. This selling pressure created a very rapid compression in the long-term GMMA and this showed that investors had joined the selling.
The third support feature is the relatively weak support level near 3,360. It was no surprise that this level offered little support, with the market plunging through this level on Feb 7. This level will possibly offer very little resistance when the market rebounds.
The Shanghai Index is now testing a very well-defined support-and-resistance trading band. The upper level of the band is near 3,290. The lower edge is near 3,260. This feature acted as a support level all through December 2017. It was a significant resistance feature in April and July 2017. It defined the market peak in November 2016.
The index dipped below this level, but closed just above 3,260. A fall and close below 3,260 has a target near 3,200. However, there is a high probability that the 3,260 to 3,290 band will act as a good support level.
The Shanghai market recovery can develop in one of three ways. The first potential development is an L-shaped recovery. This is similar to the way the consolidation base and breakout developed last December.
The second potential development is a fast and rapid reversal of the downtrend. This is a very volatile and unstable reaction. It is treated with caution.
The third potential development is a slower development of uptrend behaviour similar to that between May and June 2017. This is the most desirable development because it shows a steady recovery.
Daryl Guppy is an international financial technical analysis expert and special consultant to AxiCorp. He has provided weekly Shanghai Index analysis for mainland Chinese media for more than a decade. Guppy appears regularly on CNBC Asia and is known as ‘The Chart Man’. He is a national board member of the Australia China Business Council.
