The Limitations Of The Price Limit System Need To Be Improved.

After the stock market crash, improve the price limit system.

Chinese

Under normal circumstances, it can help stabilize the stock market, but it needs improvement to adapt to the increasingly common use of leverage in the stock market.

It is suggested that when the stock market falls sharply and the liquidity is thin, the limit of the blue chips with good liquidity will be relaxed.

Under the situation that lever stocks are becoming more and more common, China's market order system must be improved to adapt to the development of financial market.

Since June 13th, the Chinese stock market has experienced a roller coaster crash in just three weeks: the Shanghai composite index slipped from around 5200 to 3400, or 1/3.

There are many factors that triggered the stock market crash. We believe that one of the reasons is that the market liquidity failure triggered by the suspension system has enlarged the selling pressure of the market, which is particularly prominent in the new leveraged trading environment.

How to solve this problem?

The current stock price limit system in China's stock market stipulates that the trading price on the stock market can only rise or fall by 10% on the basis of the market price on the previous trading day.

The original intention of this system is to prevent excessive speculation and the manipulation of stock prices by the makers.

In addition, when there is a large number of traders who lack accurate market information and do not have the general knowledge of financial investment, stock prices are often controlled by market sentiment and gossip in the short term.

As China's stock market is dominated by retail pactions (especially when the stock market has just been established), the price limit system has played a positive role in stabilizing the stock market.

But the price limit system is artificially non market price control after all.

The recent collapse of the stock market triggered by leveraged pactions has also led us to see this serious non market price regulation, especially the suspension system.

These deficiencies are due to the new trend of China's financial market structure and investment mode along with the financial reform. We believe that this traditional limit and price limit system must be improved in order to adapt to this new normal.

In this round of the stock market crash, many stocks were opened at the same time limit, most of them even appeared in a week's continuous limit.

In this case, the system of limit sales directly leads to the whole process.

The volume of pactions is extremely shrinking, that is, the problem of liquidity exhaustion in the market.

The exhaustion of market liquidity severely limits the ability of stock holders to get cash through selling shares.

Why is the liquidity exhaustion caused by the suspension system more serious in the current stock price crash? This is mainly due to a new phenomenon in China's stock market: investors are raising stocks through leverage and financing.

For the market with leveraged pactions, the liquidity exhaustion is very harmful, and the limit stop system does not play a role in stabilizing the market, or even amplifying market volatility.

We can illustrate this situation by a simple example.

Suppose investors buy two stocks of A and B through financing.

After the stock market crash, the investor was asked to pay the deposit.

In the absence of a down board system, investors can choose to sell a stock, use the funds they earn to pay the security deposit, and then continue to hold another stock.

In such a market, even if the price of two stocks of A and B falls by more than 10%, investors will also choose to sell relatively good stocks (such as stock A), which may be large blue chips, because such "cut meat" can help investors maintain B with weaker liquidity.

However, when there is a down board system, once the two stocks of A and B are down at the same time, investors will not be able to sell shares at the same time, and two shares will be closed at the same time.

By contrast, the liquidity exhaustion caused by the market ceiling system amplifies the selling pressure on the market, which will lead to a larger share price fall and a larger area of limit, thus creating a Domino effect.

This result runs counter to the original intention of the limit system.

It must be pointed out that the stock market liquidity exhaustion caused by the down board system is very limited until the stock market is popular.

When there is no leverage stock in the market, although investors do not want to see the stock price fall, but there is no pressure to sell stocks that have fallen sharply to cash in, so stock prices slow down or fall quickly for individual investors often have little difference.

For the entire stock market, there is a better result of slow down of the limit, because slow down can help stabilize market confidence and prevent overreaction of stock prices triggered by panic selling.

But when leverage stocks are popular in China's stock market, the situation is quite different.

After a sharp fall in the stock market, leveraged investors are often forced to pay the margin by the side of the fund, otherwise they will be forced to liquidate their positions.

Under normal circumstances, investors must sell some of their good stocks for cash so as to supplement the margin of other positions and prevent them from being forced to liquidate their positions.

Unfortunately, the investors who hold down the stock will not be able to cash in the paction due to the liquidity of their stocks. They will eventually be strongly levelled, resulting in a spiral decline in the sell-off and stock prices that can be avoided in the stock market.

The above mentioned liquidity failure can be regarded as the ex post hazard caused by the market system risk.

In the case of ex ante, another negative effect of the suspension system is to provide a false sense of security and encourage the allocation of funds in a disguised way, especially in OTC.

Due to the fact that the OTC capital allocation can be closed on the same day, many agencies providing capital allocation believe that China's unique limit system guarantees their maximum daily loss of not more than 10%, claiming that the allocation of capital in China's stock market is safer and easier to control risk than the US stock market.

This false sense of security has been magnified in the stock market since last summer's continuous bull market, resulting in many managers ignoring the risk of liquidity exhaustion after the suspension.

Due to the fact that they can not sell the stocks that have been stopped, the real risk loss of the broker who provides the funds is not only 10%.

Especially when the stock has a continuous limit, the loss will increase exponentially.

Under such circumstances, the risk of loss of investors' leverage in stocks is pferred to the financial institutions providing capital allocation, which will lead to systemic financial risks.

Therefore, under the situation that lever stocks are becoming more and more common, China's current limit trading system must be improved to adapt to the development of financial market.

The general direction of the improvement is very clear: once the overall market liquidity becomes thin, the stock market should moderately let go of the limit, allowing fresh capital buyers to come in to help solve liquidity problems in time.

For example, when the whole market has a large area of stock down (for example, more than 80% of the stock limit), some of its liquidity is better.

Relax limit (for example, limit limit to 20%).

Or when the stock price is down for more than half an hour, the lower limit of the 10% is reset according to the limit price until the limit is opened.

This method is similar to some fusing mechanisms currently implemented in the US stock market.

For example, when the stock market is plunging overall, the US stock market will temporarily stop trading for a while, so that everyone can calm down.

This method can also help reduce irrational panic selling while ensuring liquidity in the market.

These institutional improvements can help leveraged investors in China's stock market to get better margins by selling better liquidity stocks when they face the pressure of liquidation.

This improvement is equivalent to opening the market for fresh capital into the stock market when the stock market lacks liquidity.

What is the conclusion? China's price limit system can help stabilize the stock market under normal circumstances, but it needs improvement to adapt to the increasingly common use of leverage in the stock market.

When the stock market falls sharply, the system will cause liquidity failure, which will cause more investors to be forced to liquidate, but it will cause more sell-off and price collapse.

This is contrary to the original intention of stabilizing the market.

We suggest that when the stock market falls sharply and the liquidity is thin, the limit of the blue chips will be liberalized to help restore the liquidity of the market and ease the phenomenon of investors being forced out of the market.