Why Does the A-Share Market Always Surge and Crash Dramatically? An Article Revealing the Truth Behind the Game Between Retail and Institutional Investors

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Many investors share a common question: why are bull markets always short and frenzied, while bear markets are prolonged and despairing? Dramatic declines in A-shares are not accidental. It is a “perfect storm” shaped collectively by the unique market structure, participant behavior, and institutional environment.

In the Chinese A-share market, domestic retail investors typically account for about 70% of daily market trading volume. This reality of retail investors as the main trading body is the foundation for understanding the market’s emotional nature and high volatility.

Key Takeaways

• The A-share market has large fluctuations because there are many retail investors who like to chase rises and cut losses.
• Institutional investors also pursue short-term interests, and their behavior exacerbates market rises and falls.
• The A-share market’s institutional design has defects, such as “emphasizing financing over investing,” which leads to market instability.
• Investors should learn value investing and adhere to long-term investment discipline.
• Regulatory authorities need to increase the cost of violations to better protect market fairness.

Retail Dominance: An Emotional “Herd Effect” Market

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The vast retail investor group forms the main trading force in the Chinese A-share market. This structure makes market sentiment extremely easy to amplify, forming a typical “herd effect” market.

Behavioral Characteristics: Chasing Rises and Cutting Losses Amplifies Market Volatility

The typical behavior of retail investors is “chasing rises and cutting losses.” They swarm to buy when they see stocks rising, fearing missing out on opportunities. When the market falls, they panic and rush to sell. This behavioral pattern greatly amplifies normal market fluctuations. Academic research also confirms this. For example, Tan et al. (2008)'s study found significant herding behavior in the Chinese A-share market regardless of rises or falls.

In the digital age, social media has become an “amplifier” of emotions. Discussions on platforms like Weibo and stock forums, whether based on facts or rumors, can spread rapidly, influencing the decisions of thousands of investors.

Related research reveals this influence:

• Jin and Li (2017)'s study found that peer opinions in stock forums are positively correlated with future stock returns.
• Yang and Guo (2019)'s research shows that increased investor attention to specific concepts (such as fine particulate matter) can directly drive up prices and trading activity of related stocks.

This collective action driven by emotions often causes stock prices to detach from fundamentals, laying the groundwork for subsequent dramatic adjustments.

Investment Philosophy: Conflict Between Short-Term Speculation and Value Investing

Many retail investors enter the market with the initial intention of pursuing short-term windfalls rather than long-term value. They care more about short-term stock price fluctuations and market hotspots, frequently trading in an attempt to capture every small wave. This short-term speculative mindset runs counter to the philosophy of value investing. Value investing emphasizes in-depth research into company fundamentals and long-term holding of high-quality assets. When the market is dominated by speculative sentiment, asset price bubbles accumulate rapidly, and once market confidence wavers, it may trigger stampede selling, causing catastrophic A-share crashes.

Institutional Game: “Fueling Rises and Falls” Using Advantages

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If retail investors are the market’s “emotion amplifiers,” then institutional investors often play the role of “fueling rises and falls.” Many people think institutions are market stabilizers, but reality is not so. Their own incentive mechanisms and information advantages determine that they become drivers of volatility in certain phases.

Incentive Mechanisms: Why Funds Also Chase Short-Term Rankings

The core revenue source for public funds is management fees. Management fees are calculated based on the fund’s assets under management (AUM), not absolute returns. This mechanism profoundly influences fund managers’ behavior. To expand AUM, fund companies have strong incentives to chase short-term market hotspots and rankings.

In bull markets, fund managers tend to herd into hot stocks to attract more subscriptions and boost asset bubbles. When the market turns, to cope with investor redemptions, they are forced to sell assets, accelerating market declines and even triggering chain reactions, exacerbating A-share crashes.

The Chinese fund industry also has some special situations that further reinforce this short-term behavior:

• Issuance-Driven Growth: The new fund issuance process is complex, leading most AUM to be secured at issuance. This prompts fund companies to continuously launch new thematic funds rather than focusing on long-term performance of existing funds.
• Severe Talent Loss: The annual turnover rate for Chinese fund managers is as high as 10-20%. Frequent manager changes make it difficult to maintain long-term fund strategies.

Unequal Game: How Institutions Profit Using Advantages

The game between institutions and retail investors is unequal from the start. Institutions have incomparable advantages over retail in capital, information, research, and tools.

In addition to technology and capital, institutions also have large research teams. They can conduct in-depth industry and company research, even directly communicating with listed company management to obtain firsthand information. This information advantage allows institutions to always discover opportunities or foresee risks earlier than retail investors. When institutions act collectively using these advantages, market volatility is sharply amplified.

Institutional Roots: Underlying Design Shaping the Game Pattern

If retail emotions and institutional games are direct drivers of market volatility, then the deeper institutional design is the underlying framework shaping all these behaviors. Many fundamental problems in the A-share market stem from its institutional roots, which determine the rules of the game and also foreshadow its outcomes.

Historical Positioning: Deviation of “Emphasizing Financing Over Investing”

When the Chinese A-share market was established, its core task was to provide financing channels for state-owned enterprise reforms. This historical positioning determined the market’s long-term tendency to “emphasize financing over investing.” The primary goal of the market is to help companies raise funds, while protecting the interests of small and medium investors and providing reasonable investment returns are relatively secondary.

This positioning has led to a phenomenon: the market focuses more on the quantity and scale of IPOs rather than the quality and long-term value of listed companies. When the market becomes a financing-oriented pump, investors’ confidence naturally becomes fragile, and the market is more prone to dramatic fluctuations due to tight liquidity.

Market Ecology: “Bad Money Drives Out Good” in Issuance and Delisting

A healthy market ecology needs inflows and outflows. The issuance (entry) and delisting (exit) mechanisms in A-shares have long been imbalanced, exacerbating the speculative atmosphere.

Since February 2023, the Chinese A-share market IPO system has fully shifted from approval-based to registration-based. This reform aims to simplify processes and improve efficiency. However, the new issuance system also brings some challenges.

• Adjusted Listing Thresholds: Mainboard listing no longer requires three consecutive years of profitability and removes restrictions on intangible asset proportions; the ChiNext also allows unprofitable companies to list. This provides opportunities for innovative companies but also allows more companies of varying quality to enter the market.
• Review and Registration Process: Although simplified, exchange review and CSRC registration remain key links. The entire process is expected to complete in six to nine months, causing IPO queues to persist and spawning speculative behavior around listings.

At the same time, the enforcement of delisting mechanisms is relatively weak. Many underperforming companies avoid delisting through various financial techniques, leading to “zombie companies” and “shell companies” rampant in the market. These companies create no value themselves yet occupy large amounts of capital, forming a “bad money drives out good” effect. Investors are keen on speculating on reorganization expectations of junk stocks rather than investing in the intrinsic value of high-quality companies, planting institutional seeds for the market’s surges and crashes.

Policy Intervention: Why It Sometimes Exacerbates A-Share Crashes Instead?

The original intention of policies is to maintain market stability, but the “policy-driven market” characteristic sometimes backfires. Policy uncertainty itself is a risk. Multiple studies reveal how policy changes affect the market:

• Influencing Investor Sentiment: Economic policy uncertainty causes investors to have biased risk perceptions, leading to low sentiment (Jin, 2008). When investors are pessimistic, they may delay or reduce investments, weakening positive policy effects (Rao et al., 2017).
• Changing Credit Environment: When policy uncertainty increases, banks and other institutions tend to reduce credit supply to avoid risks (Gilchrist et al., 2014), directly affecting market liquidity.
• Transmission Mechanism: Investor sentiment plays an important mediating role in policy transmission (Zou and Tong, 2015). An unclear or frequently changing policy will be overinterpreted or misinterpreted by the market through influencing public sentiment, ultimately possibly triggering market reactions contrary to the policy’s original intention and even exacerbating A-share crashes.

When investors are accustomed to guessing policy directions rather than analyzing company fundamentals, the market’s foundation is no longer solid. Any “slight movement” in policy can trigger collective panic or frenzy.

Regulatory Deterrence: Low Violation Costs and Market Manipulation

Effective regulation is the last line of defense for maintaining market fairness. However, for a long time, the cost of violations in the A-share market has been relatively low, making it difficult to form sufficient deterrence. According to relevant Chinese laws, penalties for securities fraud and market manipulation, although increasingly severe, still have risk-takers in the face of huge interest temptations.

Penalty Framework in China’s Securities Market

• Market Manipulation: Confiscate illegal gains and impose fines of one to ten times the illegal gains. If there are no illegal gains or gains less than 1 million RMB, fines range from 1 million to 10 million RMB.
• Insider Trading: Fines of 200,000 to 2 million RMB on directly responsible persons.
• Information Disclosure Violations: Fines of 1 million to 10 million RMB on companies with false records; fines of 500,000 to 5 million RMB on directly responsible persons.

Compared to the U.S. Sarbanes-Oxley Act after the Enron scandal, which imposes severe punishments of up to 20 years imprisonment and $5 million fines on executives, it forms a sharp contrast. In addition, China’s unique legal environment brings challenges. For example, some financial data may be considered state secrets, making it difficult for overseas regulators (such as the U.S.) to obtain complete audit information of Chinese companies, creating obstacles in cross-border regulation. When market participants believe the benefits of fraud far exceed potential costs, financial fraud, stock price manipulation, and other behaviors remain rampant, ultimately damaging the entire market’s credibility and becoming a trigger for trust crises and A-share crashes.

The dramatic volatility in the A-share market is the result of combined effects from retail emotions, institutional arbitrage, and institutional defects. Instead of going with the flow, investors should abandon illusions and build their own investment ark.

Strategies for Ordinary Investors

1. Embrace Indices: Investors can regularly invest in indices like the S&P 500 through tools such as Biyapay using dollar-cost averaging. This method uses market fluctuations to lower average costs and avoids emotional timing.
2. Learn Value: Learn to identify high-quality companies wrongly killed by the market and find deviations between their intrinsic value and price.
3. Maintain Discipline: Recognizing and overcoming psychological biases like loss aversion and recency bias is key to maintaining long-term investment discipline.

Common Questions

Can Retail Investors Directly Follow Institutional Investments?

Institutional investors also chase short-term rankings. Their behavior may amplify market fluctuations. Retail investors cannot obtain all the information and tools of institutions. Blindly following institutions easily leads to buying at highs, with extremely high risks.

Has Value Investing Become Invalid in the Chinese A-Share Market?

Value investing has not become invalid. It requires investors to have extremely strong patience and analytical ability. In the Chinese A-share market, speculative sentiment often dominates short-term prices. But in the long term, the intrinsic value of high-quality companies will eventually be reflected.

Can Full Registration System Solve the Problem of Surges and Crashes?

The registration system is an important step toward marketization, simplifying the company listing process. But it cannot solve all problems alone. A healthy capital market also needs strict delisting mechanisms and effective regulation to complement it, jointly improving the market ecology.

Why Do Illegal Behaviors Like Market Manipulation Remain Rampant?

The penalty intensity in China’s securities market is strengthening. But historically, violation costs compared to potential benefits may be low, making it difficult to form sufficient deterrence. Effective regulation needs to continuously increase violation costs.