Understanding China’s Recent Stock Market Halts and Its Importance to Investors

The trading of stock markets around the globe in 2016 so far have been marked mostly with red. This includes Singapore’s Straits Times Index (SGX: STI), which closed yesterday at 2,709 points, down by 6% since end-2015.

The most glaring example is perhaps China’s stock market, which has seen its Shanghai Composite Index and Shenzhen Stock Exchange Composite Index decline by more than 14% each year to date.

The sharp falls in the China market have also probably caused the most panic due to early closures of its stock exchanges (as a result of halts in trading) which have happened twice last week. The culprit behind the halts? The circuit breaker.

Understanding the circuit breaker

The circuit breaker is a mechanism introduced to prevent excessive price movements in the stock market in any single day. The main purpose of Chinese authorities implementing this mechanism is to prevent speculation in the market and ensure the healthy long-term development of Chinese bourses.

In China, if the CSI 300 Index – a stock market index made up of 300 of the biggest stocks on the Shanghai and Shenzhen stock exchanges – rises or falls by 5% in a day, trading will stop for 15 minutes. A rise or fall of 7% however, will, stop trading for the whole day.

The mechanism has since been suspended from use by China with no news yet on how long the suspension will last.

For some perspective, in the US, the Securities & Exchange Commission (the SEC) halts trading at the 7%, 13%, and 20% decline-thresholds for the S&P 500 index.

Why circuit breakers do not matter

Circuit breakers are often put in place to curb volatility and depending on how you approach the stock market, they may or may not matter.

The group of investors for which circuit breakers matter are those who try to profit from making short-term trades.

For example, a day trader is someone who places a trade with the expectation that he will exit his position by the end of the trading session, be it at a profit or loss. If the circuit breaker kicks in to halt trading for the day, it leaves the day trader exposed to his position and thus possibly jeopardising his trading plan.

On the other hand, long-term investors would likely not be affected negatively by circuit breakers, since they focus on investing with the long-term in mind, betting on the health of a stock’s business over a timeframe measured in years or even decades.

If the aforementioned circuit breakers from China are to be implemented in Singapore and volatile conditions cause the breakers to activate, it’s hard to see how long-term investors in companies, like say, Raffles Medical Group Ltd (SGX: R01) or Oversea-Chinese Banking Corp Limited (SGX: O39) can be affected.

The investors are not looking to sell and more importantly, the businesses of Raffles Medical and OCBC are unlikely to face adverse impacts from temporary closures in the stock market. Raffles Medical provides healthcare services while OCBC provides banking facilities; both are needed by customers on a near daily-basis regardless of what the stock market is doing.

Foolish Conclusion

“Price is what you pay, value is what you get” is a famous quote by the legendary investor Warren Buffet. If we follow his advice and invest for the long-term only when we see that a stock’s value exceeds its price, then the presence or absence of circuit breaker mechanisms matter little to us!

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Lawrence Nga doesn’t own shares in any companies mentioned.