Tuesday, January 5, 2016

Markets: The Chinese Circuit Breaker and What It Means

From FT Alphaville:

The consequences of China’s new circuit breaker
A short, occasionally speculative, always incomplete, list:

1. It makes following our rule‘don’t write about Chinese stocks before markets close because they can be relied upon to immediately move and make you look like a jerk’ — that little bit easier.
Those stocks now pause after a 5 per cent drop in the CSI 300 and, crucially, close for the day after a 7 per cent drop. Which happened yesterday. Not the biggest gap between those thresholds btw. As a comparison, via Nomura, “the US has set three thresholds of 7%, 13% and 20%, and Korea has set three thresholds of 8%, 15% and 20%.”

2. It’ll make writing about Chinese markets even more entertaining since these kinds of close together breakers tend to backfire.
As Bocom’s Hao Hong says:
The circuit breaker introduction is a mainland-specific factor. As such, it can only explain the excess volatility the mainland has experienced relative to the other markets, but not the significantly declines across the board. After the plunge on October 27, 1997 that triggered the circuit breaker in the US market, the SEC conducted a thorough investigation into that day’s trading activities. It is concluded that the circuit breaker should only be triggered during crisis, rather than be used to suppress volatility. Further, the study found that the cool-off interval between the first and second breaker was meaningless, evidenced by an orderly re-open after the cool-off. On the contrary, the second breaker had a “Magnet Effect”. That is, the anticipation of further plunge will prompt a selling stampede before the second breaker is triggered. The lopsided sell orders will hence cause further liquidity shortage. The circuit breaker that China just introduced has a low hurdle (5%/7%) that can be easily triggered, given the intense volatility in this market. The buy orders that otherwise exist to render some market support will also disappear with an overall trading halt. Once expectation for further decline is set, it can be a vicious spiral. The first breaker on the following day can become the new “magnet” for prices to gravitate towards.
And to recap yesterday’s price action we turn to Nomura once again: “The CSI-300 index dropped by 5% by 13:13 and triggered a 15-minute trading halt. After trading resumed, it then plunged by another 2% in six minutes and triggered a trading halt for the rest of the day for onshore stocks, equity ETFs, convertible bonds and equity index futures”.

China is, shockingly, open to tweaking its brand new tool. Nothing like a real time experiment in extremely fast moving markets, eh?...MORE