Date: July 9, 2015
Asians have an unsavoury reputation for gambling, and so it may not come as a surprise to hear the comparison between China’s stock markets and casinos. A gear-shift to policy intervention, including monetary easing and fiscal stimulus, perpetuated with a belief that more of both is to come, help to explain the rally. The main driver, however, is the growth in margin trading.
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Margin financing is buying stocks with “borrowed” money from your broker. While the shape of the current bull market may look similar to the stock run-up in 2007, there is one key difference. Previously, investors were unable to buy stocks on credit. This time, the Chinese regulators had allowed margin trading since 2010, and investors have took to it like fish to water. The outstanding margin debt in China more than quadrupled in the past year to reach a record high of CNY 2.27 trillion ($365 billion) on 18 June 2015, according to the China Securities Finance Corporation.
As a proportion of total China market capitalisation, outstanding margin debt doubled to almost 4% on 18 June 2015 from 2% at the start of July 2014. Despite share prices having little connection to underlying economic conditions, mainland equities have seen an ‘unbeatable’ rally. That was the case, until recently. Volatility in the Chinese shares pumped up since May. If you look at the average true range of the CSI 300 Index, you will see a huge increase in the value from below 100 in April to around 250 at the end of June. The remarkable bull run in the China markets have seen many traders making outsized profits but increasing variability is causing some to rack up huge losses. The volatility is magnified if one is using leverage in the trades. Risk and money management As far as trading goes, market risks are something you must take into consideration when planning a trade. Trading the Chinese markets becomes extremely challenging given its unpredictability nature. Fundamental and technical analysis alike seems to be less effective in presenting a clear directional bias in such a volatile environment. Therefore, a solid trading system is even more critical. Risk control and trading rules can help you minimise the impact of losing trades and maximise your winning trades. Many individual traders clamour for that one big trade that will earn millions and set them up for life. Certainly, many of the Chinese retail traders, where more than two-third of new investors have never attended or graduated from high school according to a survey by China’s Southwestern University of Finance and Economics which was reported by Bloomberg on 1 April 2015, are probably visualising the Big One. However, successful traders rarely become successful from one lucky break. They make money consistently from their trades. One quality of professional traders is that they always know how much capital they are risking and what their potential profits are. A key part of risk management when planning your trade is to set your stop-loss and take-profit points. By doing so, it not only allows you to know your potential profits and losses, it also takes the emotion out of the trade. Unsuccessful traders often place a trade without such tools, allowing emotions to take over and dictate their actions. On many occasions, they cut their profits too early or let their losses run. Money management is an essential part of risk control. The 2% rule is an oft-followed restriction imposed by investors to manage their capital. Never risk more than 2% of your outstanding capital per trade. Please bear in mind that the 2% is not a hard and fast limit. You may set it at 1% or 5%, or a percentage which you are comfortable with. Needless to say, the idea is not to risk a majority of your capital in a single trade. Entering a trade with a huge chunk of your capital may put you out of the game a lot sooner. By risking only 2% per trade, it means that you would have to sustain 10 straight losing trades to lose 20% of your outstanding capital. This would still leave you with 80% of your account intact. Another money management philosophy stems from the idea that you do not need to have a 100% winning record, which is surely impossible. Let’s say you set a more realistic win rate target of 40%. It means you need to make eight winning trades out of 20. The key to achieving this target is to structure your trades so that your winners profit at least twice that of your losers. If you trade using leverage, there is a need to ensure that your initial capital can withstand the inevitable string of losses. Successful trading is not just about maximising winnings but also about minimising losing trades. By managing your losses, you are able to weather tough market conditions or a highly volatile environment much better. This means you will be ready to take advantage of profitable opportunities when they appear. This article is contributed by IG Disclaimer: |
