The Shanghai Composite Index fell 1.3% on July 7, days after the Chinese government vowed to prop the benchmark index up. It has a lot farther to fall, says Victor Shih, professor at University of California, San Diego.
“[E]ven with a government rescue, it could be quite some time before the backlog of existing sell orders are cleared,” Shih tells Quartz. “This will continue to out downward pressure on the market.”...
When stocks drop enough that brokerages get twitchy about ever being able to get their loans back, they demand that their clients pony up more money or stocks as a deposit. If these “margin calls” force enough liquidation at the same time, it can create a cascade of falling share prices, that in turn spark more margin calls.
In China’s case, a lot of that margin finance flowed into the most speculative part of the market, super-volatile small-cap stocks, says UCSD’s Shih—the stocks that have been tanking the hardest.
More in Quartz.China tries to prevent margin call disasters with a rule suspending a stock from trading for a day once it’s lost 10%. But that does not actually solve the problem—it just stalls it.“When the stocks began to sell off, margin calls rolled in,” says Shih. “However, because of the rule… margin lenders could not liquidate positions in many cases.” Even though not all the positions have been sold out, stocks are down to practically where they were before the recent several-month bubble.
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