As I’ve said in prior posts, I have no desire to buy shares on mainland China’s stock exchanges.  Hong Kong is fine enough for me.

This has led me to not pay enough attention to what may be a key feature of trading there–daily price fluctuation limits of +/ – 10% per day.  What this means in the current context is that a given stock can trade down until it has fallen by the maximum 10%.  Unless/until there are buyers at the -10% level or better, there is no more trade in the stock that day.

While this was common practice in stock markets around the world several decades ago, and is the norm in commodities trading, it is no longer the case in most stock markets.

The reason is that it prevents markets from clearing quickly in times of stress.  It tends instead to increase investor fears and to deepen stock market losses, as well as lengthen the selloff period.  I first saw this very clearly in the cases of Mexico, Spain and Thailand during the market downturn of October 1987.  All three countries had daily fluctuation limits.  After a number of days of limit-down-no-trade, Mexican authorities loosened the bands and the market began to clear.  Spain and Thailand didn’t.  Both markets suffered severe selloffs that lasted for months.

Press reports on China have alluded to the daily price fluctuation rule there.  But the authors haven’t a clue as to its significance; they provide no useful information about how it is impacting trading.  They do indicate that many small caps aren’t trading, but that would likely be the case whether price limits were in effect or not.  (Typically, one of the early signs of market recovery is that small caps go down.  The positive signal is that buyers–at any price–have reemerged.)

The 10% rule may be having negative effects on Chinese stock markets. The way to tell would be to examine the most liquid stocks and see if they are closing on the lows, with the last trades significantly before the market close.  Given the behavior of the overall indices and the overall trading volumes, I don’t think this is the case to a crucial degree.  But at this point I’m not curious enough to check.

Even so, it seems to me that Beijing could shorten the period of margin-selling downward pressure on the market if it were to modify or eliminate its old-fashioned daily limit rules.