An investor looks at an electronic stock information board at a brokerage house in Nanjing, Jiangsu Province, China.
BEIJING – The recent frenzy over short selling on Wall Street is unlikely to come to China, where many more market restrictions are in place.
Short selling refers to a trading strategy that allows investors to bet that the price of a stock or security will fall.
To short a stock, investors borrow and sell shares, and ideally buy them back later at a lower price and deposit the profits made. If the stock price doesn’t fall, the short seller will try to minimize the losses by buying back the stock, which now costs more.
Investors in mainland China have limited options to go short on stocks – a sign that the local markets are still immature. Strict regulations and online censorship in China also contribute to different investor behavior than in the US.
Millions of individual investors since last month have stacked up in the WallStreetBets forum on Reddit, encouraging each other to bid on shares of stocks that have shorted hedge funds or bets would drop in price.
A rush of trades through stock brokers such as the free Robinhood app caused stocks of highly short-short stocks such as GameStop, a video game retailer, to jump 400% within a week.
Shares of GameStop and others targeted by the Reddit community have since fallen dramatically – but not before some of the funds betting against them lost billions of dollars.
Why Chinese Stock Markets Are Different
Here’s why analysts say something similar is unlikely to happen in China:
First, the concept of short selling is relatively new and limited in scope in the country, where authorities are very vigilant about managing risk.
Regulatory bodies only started allowing short selling about 10 years ago, and it remains well below 1% of the total market value.
The process is essentially the same as the profit of US traders by borrowing shares, selling them, and then buying them back after prices drop.
But one difference in China is that regulators only allow investors to go short on some of the stocks traded on the Shanghai and Shenzhen stock exchanges.
According to Bruce Pang, chief of macro and strategy research at China Renaissance, the list of stocks – roughly 1,600 or more – changes frequently and typically only includes companies with good fundamentals.
This contrasts with the short selling environment in the US, where dedicated funds typically choose companies like GameStop for perceived weaknesses in their business.
The limited ability to go short on Chinese stocks and caps of 10% or 20% on daily price movements gives speculators more incentive to pursue various strategies to make money, such as driving up prices before selling.
In the US, individual stock trading can be interrupted due to excessive volatility, but prices can eventually rise or fall, such as GameStop’s rise of over 130% one day and a drop of 44% the next.
Stability at all costs
Chinese regulators are prioritizing stability in formulating economic and financial policies – even if they want to improve the business environment by attracting more foreign investors and increasing the role of stock markets in financing Chinese companies.
That mindset has affected local equity investors, who tend to assume implicit government support means that Chinese stocks will only rise. Local interpretation of official signals has also sparked bouts of speculation in the mainland stock market, leading many to call it a “casino.”
But as millions of ordinary individuals, rather than institutions, dominate China’s stock trading, regulators want to avoid widespread losses as a way to ensure stability.
That means authorities will take extra precautions to control the markets, and it would be very difficult for a large group of retail investors to fuel the frenzy recently seen in US markets.
All short trades and online discussions about stocks are closely monitored, Pang said. So, in a sense, investor protection in China is greater than that of more developed markets, he added.