In recent months all the rage has been talk about the Chinese stock market and how aggressively it has rallied, but probably more concerning on how many “retail trading accounts” have been opened. Which to me, is probably the scariest part of the analysis that you will see below.
When I say “scary” what I mean by that is when everyone (I mean everyone) is buying stocks, and especially people that typically don’t (and probably don’t even have the means to dabble in the markets) invest in the markets, it becomes very concerning. In today’s market I think the term “bubble” is grossly overused. But in terms of the Chinese stock markets, I think it may be appropriate. Here is Wikipedia’s definition of “Stock Market Bubble”
Behavioral finance theory attributes stock market bubbles to cognitive biases that lead to groupthink and herd behavior. Bubbles occur not only in real-world markets, with their inherent uncertainty and noise, but also in highly predictable experimental markets. In the laboratory, uncertainty is eliminated and calculating the expected returns should be a simple mathematical exercise, because participants are endowed with assets that are defined to have a finite lifespan and a known probability distribution of dividends. Other theoretical explanations of stock market bubbles have suggested that they are rational, intrinsic, and contagious.
Emphasis on behavioral finance theory is mine.
Below, I take a look at the Shanghai Class A shares and I want to show you the weekly chart since 2007:
We have a cluster of Fibonacci (Golden, mind you…) levels with a 68.8% retracement from the 2007 highs to the 2008 lows. But also a 161.8% extension from the 2009 highs to the 2013 lows. That massive cluster comes in approximately at 4700.
Since many traders here stateside trade the Hang Seng, I started to wonder what those charts looked like. First, the monthly chart:
You will notice that we had slightly over-shot the 78.6% retracement level as we exploded higher out of the wedge pattern last month. Here is the daily:
After reports about the explosion of retail accounts opening in late March, the first couple weeks of trading in April caused price inefficiencies (aka gaps). As traders, most of us believe those “gaps” will eventually be filled as prices come back down. Also, you may notice that there is a head and shoulder’s technical formation with a neckline at about 27,000.
If you are long the Chinese stock market, or Chinese equities, I think you should pay close attention to what’s happening in Asia. We have rallied pretty sharply in recent months. And if you ask me, it seems like everyone is on the same side of the market. And when that happens, usually the opposite will occur.
Chief Currency Strategist, Wizetrade
Disclaimer: I have no position in any Chinese markets or currencies.