Source: Steel Seal of Thought

1. How does risk appetite affect stock prices?

If you only look at the immediate cause, why is the stock price falling?

Many people think that the decline means that there are more people selling stocks than buying stocks. This is clearly inaccurate.Regardless of whether it goes up or down, a deal is always the same as the number of transactions and the amount.

The real reason is risk appetite.

If you really want to sell a stock, then you must be selling at the same price as shown below. As shown below, then your sale will lower the current price by 1 cent. If your capital is too large and the number of 735 hand orders you buy is not enough, you will have to keep selling downward on the buy 2, buy 3, etc., and the stock price will continue to fall.

So who is actually waiting in line to buy one, buy two, buy three? Since orders are placed, the mentality is naturally “buy it, pick it up cheap, and there's nothing to regret if you can't buy it,” or if there are strict purchase price restrictions, this type of purchase capital will not increase the stock price.

So, the immediate reason for the stock decline is,Funds continue to sell below current prices, and few investors are willing to buy higher than current prices. This change is a “decline in risk appetite.”

The decline in risk appetite is the direct cause of the decline. It directly determines whether you are active or passive, price ranking of pending orders, transaction frequency, etc. Everything else is indirect.

Moreover, “declining risk appetite” only indicates a strong willingness to sell; it does not indicate a profit margin. If large sums of money are urgently needed to return funds and a large amount is sold off at low prices, triggering a one-day sharp decline with no advantage will occur.

“Risk appetite” falls under the category of investment behavior research. The reason for temporarily abandoning common analytical methods of value investing is to re-understand the rise and fall of stock prices from this perspective, because it has a direct relationship with the characteristics of the bottom and top of the A-share market.

But before analyzing risk appetite in depth, I'm guessing many readers also have an important question: capital inflows and outflows can also cause the stock market to rise or fall. Their impact on the market is greater than risk appetite, which one is greater?

II. Competition based on risk appetite

The inflow and outflow of capital causes the market to rise and fall. This statement is very intuitive, but understanding it alone is not enough.

Since most investors have fund accounts and stock accounts, there is often an internal flow between these two accounts, which makes the path of capital inflow and outflow of the entire stock market very complicated, so I will use the “foreign capital” category of special investors without capital accounts as an example.

The northbound capital entering A-shares through the Shanghai (Shenzhen) Hong Kong Connect has no domestic fund accounts.When you buy A-shares, it's a pure inflow of capital; selling is a pure outflow; a net purchase is equal to a pure additional capital.

The “equal buying and selling” we mentioned earlier does not mean that the bidding and auction funds “waiting to be bought and sold” are also equal.When a number of foreign investors bought more in the market, it was tantamount to an increase in “bidders,” but there was no increase in sales, the principle of reciprocity in buying and selling,This means that the bid with the lowest price ranking (that is, the lowest risk appetite) will not be sold.

So the net inflow of capital did not directly boost stock prices, but ratherFunds with high risk preferences are allowed to be squeezed out of purchases that originally had low risk preferences through the transaction mechanism of bidding rankings, thus driving up stock prices.

I call it the “replacement effect” of funds with different risk preferences.

As you can see from the picture above,If there is incremental capital entering, it will definitely increase the amount, because incremental capital has also sold the seller's high-risk appetite funds; but if it's just a change in risk appetite(For example, the high level of the market continues to be favorable),Then it won't necessarily release the amount.

The process of decline caused by net sales of foreign investors was just the opposite. The increase in the amount of auctions exceeded the number of auctions. Auctions competed with risk preferences among auctions. Among them, sellers with lower risk appetite were willing to accept lower prices, causing stock prices to fall.

In fact, not only foreign capital, but any net inflow or outflow of OTC capital boosts stock prices by changing the risk appetite of buyers or sellers.

After understanding the special situation of net capital inflows and outflows, we can further understand how stock prices rise without incremental capital.

3. The two stages of a rising market

As mentioned earlier, an increase is active buying in response to passive pending sales orders. So,Active buying is an investor with a high risk appetite, the mentality is in a hurry to close the deal, butPassive sellers are investors with low risk appetiteThe mentality is more Buddhist.

This chip swap led to an increase in the stock holders' overall risk appetite during an upward processSo from the perspective of a “chip structure,” we can define the rise in stocks one more time --

The so-called rise in stocks is a process where low risk preferences among shareholders are gradually replaced with high risk favors.

The net inflow of capital to the north mentioned earlier and its impact on A-shares is often divided into two stages:

1.On the day of the large net inflow in a single day (over 10 billion dollars), the “replacement effect of domestic and foreign capital” was reflectedRisk appetite has increased in sectors such as the Shanghai and Shenzhen 300, liquor and Hakuba, etc., which favors foreign investors, and stock prices have risen, while other sectors favoured by domestic investors have declined due to declining risk appetite.

2.The inflow of foreign capital continued for several days, leading to an increase in the overall risk appetite of the market, reflecting the “replacement effect of high and low risk preference funds”Most sectors have seen high-risk preferred funds replace low-risk preferred funds, and most sectors are rising.

It's not just foreign investment; any large-scale continuous increase in capital will reflect the characteristics of these two stages:From a structural increase to an overall increase.

As stocks continue to rise, the proportion of those with high risk preferences among shareholders is getting higher and higher. What are the behavioral characteristics of those with high risk preferences?

IV. Two types of high-risk preference funds

A person has a high risk appetite, which meansWilling to take greater risks to pursue high returnsLeaving aside differences such as personality and knowledge structure, etc., it is often related to their investment methods.

High returns come from either high win rates or high odds, so investors with high risk appetite also fall into two categories:

The first category is based on a high win rate, which is often when the market is particularly good, when everything buys goes up, or experts who are good at short-term trading. When trading volume is relatively active, the winning rate of shots is also particularly high;

The second category is based on high odds and has nothing to do with the market atmosphere. They are looking for varieties that have a lot of long-term room and are willing to spend time uncertainty and high fluctuations in the process to obtain high long-term profits.

When a stock or index has just risen from the bottom, there are both types of investors with high risk appetite, butWith the further rise in stock prices, the share of those pursuing high odds in the second category gradually decreasedBecause the odds are related to future stock price space, the higher the odds, the lower the odds, which no longer meet the requirements of second-class investors.

whereasIn the first category of investors, the higher the win rate in the short to medium term on an upward trend, naturally they account for an increasing proportion.They like the market environment with a high turnover rate the most, the effect of constantly switching between sectors, and the continuous exploration of dark horses within the same sector.

When the market rises to the point where there are only the first type of high-risk investors left, the market will form two mutually restrictive phenomena:

Attracting liquidity: A high short-term win rate attracts a large amount of OTC capital to join, supporting on-market liquidity

Liquidity consumption: High turnover rates consume capital very seriously and require higher liquidity

There are three types of results:

1. The continuous rise of the index attracts more liquidity than consumes liquidity;

2. When these two types of capital movements reach a balance, the sector takes turns peaking, and the index fluctuates at a high level, that is, the common double top in morphology, head and shoulder, multiple tops — so morphology is only a representation; capital movements guided by risk appetite are the reason for peaking;

3. When the macro side is due to certain reasons (such as the central bank tightening liquidity),Liquidity is not enough to support turnover(that is, risk appetite),The index uses a decline to reduce the turnover rate(i.e. risk appetite)Requirements.

Let's take another look at the characteristics of the market during the decline.

5. Why is shrinking a prerequisite for the general market to bottom out

The net outflow is the opposite; in fact, it isFunds with low risk preferences replace funds with high risk preferences, leading to a decrease in risk appetite in the entire market.

Therefore, if you want to understand the bottom line, you also need to understand the characteristics of low risk preference funds. They can also be divided into two categories:

The first category is quantitative capital that likes to do super-fall rebound strategies, high-sell-off and low-suction capital, and T0 strategies

The profit method for this type of capital is to return to the average value and cut the bottom. The most common method is to place a low order with small capital and actively buy at the bottom after a sharp decline. The latter seems to be active buying, but from a methodological point of view, it is more similar to a low price pending order.

The second category is value investors' low frequency purchases

This type of capital is easy to understand. The most common practice of value investing is to gradually increase positions when they fall to a safe margin below a reasonable valuation.

Although these two types of capital are bought on dips, the methods for making a profit are not the same. The former uses short-term high and low interest, buys bloody cut-cutting chips, and then sells them to people chasing the rise, soIt also relies on a certain turnover rate. It is active at the beginning of the decline, but after falling to a certain extent, turnover always tends to shrink. As a result, this portion of capital cannot find an opportunity; it can only gradually rest.

The latter type of capital buys only the company's fundamentals, focusing only on the price itself, not on price trends. In addition, it is held for a long time, so even if it is a large amount of money, it can slowly lose weight in companies with a very low turnover rate.

At the beginning of the decline, the first type of capital accounted for a high share; it fell to the stage of volume reduction, and the second type of capital accounted for a high share — the general market, the sector, and the same was true of individual stocks.

So when judging the bottom of the market, always useVolume reduction as one of the bottom indicators, because the fundamentals of the market are not changing as fast as the sector and individual stocks,Volume reduction means that chips are gradually shifting from trend traders to value investorsThe higher the share of shares held by value investors, the higher the probability that the market will bottom out.

Of course, volume reduction is not effective all at once. These two stages also occur in a cycle. After a period of volume reduction, there is a slight rebound in volume, but since the macro environment that caused the decline did not change, it returned to a new round of decline after a period of decline.

No matter how much the stock price falls, it must be in the hands of someone. When he decides to continue selling to investors with lower risk appetite, the stock price will continue to fall until those who hold these stocks decide not to sell them.

So the reduction in volume is just an impression.The real reason for the bottoming out is that the share of high-risk preference funding has reached its lowest point.

Moreover, seeing the bottom does not mean that it can rise. As mentioned earlier, a rise requires the reintervention of high-risk preferred funds. However, an increase in risk appetite, either a high win rate or high odds. A high win rate requires the market or sector itself to become active again, macroscopic changes or changes in industry trends, and a high win rate requires a relatively large change in the fundamentals of the enterprise; it is not something that can be changed overnight.The pattern we have seen over and over again is actually just waiting for the factors that lead to a change in the fundamentals of “high win rate or high odds”. Market participation value is average.

6. Differences between the Chinese, American, and Hong Kong stock markets

The risk appetite perspective can also explain the differences between the Chinese and US stock markets, the differences between A-shares and Hong Kong stocks.

Both A-shares and US stocks are markets with good liquidity.The biggest difference is the shorting mechanism.

After US stocks have risen to a certain level, there will be shorteners with low risk appetite, correct excessive gains, and the rate of increase will not deviate too much from fundamentals; after falling to a certain extent, there will be shorteners with high risk preferences. It is a typical trend transaction. Funding similar to the accelerated rise of A shares often causes stock prices to quickly overfall. Although the process is painful, it can quickly drop out of an excellent opportunity for long-term investors to intervene.

Exactly this kindHigh-level low-risk-preferred shorting funds and low-risk-preferred shorting funds have caused US stocks to show a healthy trend of slow bullish and fast bears, which is most suitable for retail investors to invest in the long term.

On the contrary, A-shares can only make a lot of money, and the rise can easily accelerate. When falling, large amounts of capital are undercut, making it difficult for stock prices to fall through quickly, causing a pattern where A-shares are fast rising and falling slowly.

Some people said that Hong Kong stocks also have a shorting mechanism, so why aren't there any slow bulls in US stocks?

This is because Hong Kong stocks have been losing long-term capital (mainly European and American pensions and sovereign funds) since 2018. As previously analyzed,Long-term funds are usually low-risk funds. They like to go to the bottom. They are the core force of market stability. As long as this type of capital is in a state of long-term net loss and there is no other long-term capital supplement, the market will never bottom outEven the lowest price-earnings ratio is possible.

At the same time, since Hong Kong stocks have a number of excellent leading mainland listed companies, there has been no decline in funds with high risk preferences — mainly hedge funds.Once the external environment of Hong Kong stocks changes, the market's risk appetite will rise sharply, and the sell-off without low-risk preference funds will slow down. The result is a brief volcanic eruption, quickly bringing market valuations back to normal levels—and then... there's nothing else.

The “bottomless giant bear+rapid bull run” is the biggest characteristic of Hong Kong stocks in recent years. Behind this is a low risk preference and loss of long-term capital. Don't think that Hong Kong stocks just have excellent listed companies. Without changing this malformed financial risk appetite structure, Hong Kong stocks will always be an extremely unfriendly market for retail investors.

edit/lambor