Analyses and suggestions on short trading in bond market

 

 

According to historical records, "short-trading" emerged in the early 17th century on the European securities markets, and has a history of over 400 years. First appeared in Netherlands, short trading then spread to other developed countries such as Britain, France, and the United States. Initially, short trading on the market was unrestricted, but after the collapse of the securities market, regulatory authorities prohibited this type of trading. Afterwards, short trading resumed gradually with market changes. The vitality of short trading is thus quite impressive.

 

Advantages of short trading lie in that it slows down the growth of bubbles in financial markets. Like a sword hanging over the market, short trading always reminds participants that financial market bubbles cannot expand too large. If the market price becomes too high, or the price goes beyond its normal range, the sword's edge would then pop the bubble and end its expansion. Moreover, short trading can increase market liquidity, which serves as a significant indicator for a mature market. Lastly, short trading can ward off market risks. Market risk refers to the possibility of potential loss from changes in market prices, and is another major risk besides credit risk. Through selling short, however, investors may buy and sell the same amount of bonds at different points of time, thus reaching the goal of locking in bond yields or risks.

 

There are also several disadvantages of short trading. To begin with, short trading is not conducive to primary market financing. As the universal rule of "buying long not short" shows, investors will never make great investment when the market is heading lower. But short trading means shorting the market. Thus, the financing functions of the primary market will be weakened. Secondly, short sellers gain their profits at the cost of losses by most investors, as short sellers earn returns by pressing down prices, while most other investors rely on profits by driving up prices. Thirdly, buying long can channel funds into industries, thus realizing the transfer of funds from a virtual economy to the real economy and increasing social wealth through investment. The existence of short trading transaction can merely dent the investment and financing functions of the market. Lastly, short trading can easily lead to dramatic fluctuation in the securities market. If short sellers, due to their misjudgment, suffered losses beyond their endurable amount, the smooth operation of the market would be affected.

 

The author puts forward some suggestions on the introduction of bond short trading in China. First, we must enhance our knowledge of short trading. In light of its history in international financial market, permission for short trading is an inevitable trend as financial market grows. As China opens its capital market and introduces the QFII, whether short trading is allowed or not has become a prerequisite for foreign institutional investors. Second, the construction of risk prevention mechanisms should be accelerated so as to bring risks from selling short under control. Third, short trading must be introduced in a step-by-step manner. Bonds circulating in large amounts and moving steadily in the market may be chosen first as pilot varieties so as to acquaint the market with the characteristics, rules and risk prevention patterns of short trading. In this way, the market can accumulate experience and create favorable conditions for promoting short trading transactions.