Interpreting price momentums in Chinese stock markets

Certain retail investors fuel daily price changes in emerging stock markets, but these fluctuations may be prone to loss

By Putro Harnowo, Senior Content Manager, China Business Knowledge @ CUHK

There is a tendency for stocks that have performed well in the past to continue performing well in the short term and vice versa. This pattern is called price momentum, which reflects the idea that past performance can influence future stock movements. In the US stock markets, this price momentum presents in the medium-term range of one to 12 months before it reverses in the long-term range of two to five years.

However, such medium momentum and long-term price reversal are absent in Chinese bourses, despite being the world’s second-largest with more than 4,700 listed stocks. Instead, their stock prices exhibit strong momentum at the daily level, indicating daily price momentum.

“In daily price momentum, stocks in Chinese markets exhibiting strong performance today are likely to maintain this outperformance tomorrow,” says Jiang Wenxi, Associate Professor in the Department of Finance at the Chinese University of Hong Kong (CUHK) Business School. “This momentum persists for one to two days before exhibiting a reversal within a week.”

“The Chinese stock market is predominantly occupied by retail investors and is characterised by frequent influxes of new investors, a common trait among emerging markets.”

Professor Jiang Wenxi

In a research paper titled Daily momentum and new investors in an emerging stock market, Professor Jiang and an Associate Professor in the same department, Gao Zhenyu, along with Xiong Wei A of Shenzhen Stock Exchange and Xiong Wei of Princeton University, tried to cast light on this phenomenon.

“The Chinese stock market is predominantly occupied by retail investors and is characterised by frequent influxes of new investors, a common trait among emerging markets,” says Professor Jiang. “These new investors, possessing limited investment experience, are prone to cognitive biases and susceptible to the emotional impacts of market fluctuations.”

The main voice behind the noise

Professor Jiang and the team analysed daily, weekly, and monthly stock return data from the China Stock Market and Accounting Research database. The sample covers stocks from two major bourses, the Shanghai Stock Exchange and the Shenzhen Stock Exchange, from 2005 to 2019.

A distinct feature in Chinese stock exchanges is the ability to track all trading activities of individual investors across various brokerage firms using national identity documents. The researchers then categorise new investors as those who opened accounts within the past three months and have traded at least one stock.

Those with less and more than three million Chinese yuan investments are grouped as experienced retail investors and large retail investors, respectively. The researchers also track the transactions of mutual funds and other institutional investors with large capital, such as pension funds and insurance companies.

New investors are found to take up only 2 per cent of the market share, yet the most active, with daily turnover rate of 18 per cent, referring to the percentage of total shares that are bought and sold daily. Unfortunately, the monthly net buying by newbies tends to negatively predict stock returns in the following months.

Experienced retail investors share the same fate. The difference is the large number, as these investors hold the most significant part of the trading volume with 65 per cent. “The high trading intensity and poor stock selection make the two groups of new investors and experienced retail investors noise traders in the Chinese stock market,” says Professor Jiang.

After looking at the previous day’s stock performance, the team found that new investors’ trading behaviour has a direct impact on short-term price changes and leads to a decrease in the stock price in the following days. Meanwhile, based on the previous day’s performance, experienced investors’ trading behaviour showed a positive effect on today’s price but a negative effect in the following week and month. In short, both groups are proven to influence daily price momentum and the subsequent price drop.

“It is plausible that some experienced investors barely meet the threshold of possessing three months of trading experience and consequently, exhibit trading patterns akin to those of new investors,” says Professor Jiang.

Numerous news reports have detailed how investors spend excessive time monitoring, deliberating, and trading stocks. However, there is not enough data on how much attention Chinese retail investors are paying to the stock market related to daily price momentum.

The existing literature on investor attention shows that retail investors tend to focus more on the market when stock prices are going up. A further analysis confirmed this and found that new investors are more likely to follow daily price trends when the market is doing well. Their trading activities also have a bigger impact on daily price momentum during times when the market is performing strongly.

Strong investors as the gatekeepers

While new and experienced retail investors make the noise, large retail investors, mutual funds, and other institutional investors demonstrate lower turnover rates and superior stock selection skills. These groups’ monthly net buying tends to serve as a positive predictor of stock returns in the following months.

Large investors’ daily net buying activities are linked to a drop in stock returns on the previous day. When large investors buy stocks based on the previous day’s stock return, it links to a decrease in the stock return on the current day but increases the stock return in the following weeks.

A deeper analysis reveals that mutual funds normally buy stocks that perform well the day before, indicating a momentum trading pattern. Mutual funds that buy stock on the current day based on the performance on the previous day usually lead the stock price to drop on the current day but are linked with the rise of stock return in the following week and month. This shows that, although at first it might seem otherwise, mutual funds balance out the price momentum.

“Taken together, we find that new investors and experienced retail investors significantly contribute to daily price momentum and subsequent price reversal, while large investors, mutual funds, and other institutions counterbalance these price effects,” says Professor Jiang.

Similar trends worldwide

Professor Jiang and the team further explore whether daily momentum is also visible across stock markets worldwide by looking into international stock return data from 1980 to 2023 in DataStream, which covers more than 100,000 stocks from nearly 200 countries.

The team narrowed down its observation to emerging markets like Brazil, Chile, Mainland China, the Czech Republic, Egypt, Greece, India, Indonesia, Israel, Malaysia, Mexico, Pakistan, the Philippines, Poland, Saudi Arabia, South Africa, South Korea, Taiwan, Thailand, Turkey, and Vietnam. They also examined developed markets like Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong Kong, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the UK, and the US.

The result found that 14 emerging markets, including Chile, Mainland China, the Czech Republic, Egypt, Greece, Israel, Mexico, Pakistan, Saudi Arabia, South Africa, South Korea, Taiwan, Turkey, and Vietnam, show strong daily momentum patterns. Surprisingly, daily momentum was also found in three developed markets, namely Austria, the Netherlands, and the UK. Many of the above markets show daily momentum patterns during bullish and bearish times, similar to the trend in Mainland China.

“The significant occurrence of daily price momentum in these emerging markets lends weight to the notion of new investors exerting a meaningful influence,” says Professor Jiang. “It’s plausible that the intensified trading activity of these new investors during bullish periods amplifies the observed asymmetric patterns in those emerging markets that display daily momentum effects.”