It has been a volatile month for Chinese stocks as the margin fueled boom in share valuations was quickly met with a sharp and painful correction for many investors. The Hong Kong Hang Seng Index (HSI) proved not immune from the regional developments with August marking the worst month of losses in 4 years. This marks four-straight months of losses in the key Asian equity index as concerns about the outlook grow amid fears that a global trade downturn has enveloped China. With the latest data confirming a slowdown is in progress combined with a major margin call for investors, the unwind looks like it has just begun, evoking many similarities to the Asian financial crisis of the late 1990s.

The Fundamental Picture

The Hang Seng Index is the flagship benchmark for the Hong Kong Stock Exchange, comprised of 48 stocks that represent the majority of the market capitalization of the exchange. Constituents of the index are picked based on a variety of criteria, namely market value, trading volume, and listing history. While the Hang Seng was among the best performers of 2015 for the first quarter of the year, around the second quarter conditions began to shift, beginning in April when the index peaked. Since then, concerns about the Chinese economy and the prospect of higher interest rates in other developed economies have taken their toll on the index’s valuation, seeing a massive correction that wiped away two years of gains in a very short time span.

Much of the gains attributed to the index in the past year came on the back of momentum fed by the retail trading community. China saw an unprecedented number of new retail trading accounts opened over the past year as liberalization of the stock market combined with a crackdown on gambling in Macau saw individuals shift their attention. However, the massive uptick in retail brokerage accounts was accompanied by an epic expansion in margin trading debt which fed the rally that invariably saw the Hang Seng soar after the middle of March. While many investors spent time cheering the gains and ordinary retail investors chased after a market with tremendous momentum, for many of these newly minted traders, the story ended in tears.

The bubble mania that found its way to stocks had all the attributes of other asset bubbles witnessed over the years, but few investors imagined that the correction would be so sharp. When combined with the recent spate of bad economic data including the preliminary official manufacturing PMI released overnight, it is quite clear that more downside is in store as market valuations catch down to economic reality. Due to the fact that much of the gains in the regional indices were attributed to increased margin debt, the unwinding of that debt is likely to see a further cascade lower in valuations despite efforts on the mainland to prop up share prices with numerous measures designed to prevent selling. Until the last margin call is made, finding a silver lining in the Hang Seng Index is extremely challenging.

The Technical Take

The Hang Seng has trended progressively higher over the years after rebounding from the last financial crisis, seeing an acceleration in upside in recent months. A look at the longer-term trends show that the index was sustainably trending higher in an equidistant channel formations since 2011 until the Hang Seng broke out to the downside in a move that was accompanied by substantial downward momentum. A correction of this magnitude had not been witnessed in years, leading many to believe that it has just begun and is not nearing the end. Volatility in the index has been so ferocious that intraday swings over several percent are not uncommon, making this a tremendous opportunity for swing traders that are flexible. The key is waiting for an overextended move and jumping on the counter-momentum. Trying to chase after the momentum often results in buying tops and selling bottoms.

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From a near-term technical perspective, the breakout from the channel is a strongly bearish reversal in the Hang Seng. Even though the RSI is currently showing the Hang Seng as being oversold at the moment, potentially signaling an intraday Call position opportunity, it is worth noting that the 50-day moving average crossed the 200-day moving average to the downside on August 21st, marking the “death cross.” This is strongly indicative that much further downside has yet to be realized, adding to the case for taking intraday Put positions anytime the Index rallies and taking longer-term Put positions with the expectation that the correction will be prolonged by the softness in the underlying economic data for the foreseeable future. Until the margin unwind is completed, the ride downwards will prove tumultuous.

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Conclusion

The confluence of fundamental and technical factors has seen one of Asia’s flagship equity indices face a sharp uptick in volatility as the chaos in mainland Chinese stocks reaps havoc on asset valuations. With the rout ongoing for four months now, no end is in sight as margin trading debt remains high, fueling the volatility and adding to investor woes. With intraday volatility measuring swings of several percent some sessions, this is a great opportunity for traders with a flexible and short timeframe for trading, with optimal positions taken to offset momentum. Sharp rallies in the Index should be viewed as great for initiating Put positions while a sharp decline could be viewed as a great time to start evaluating Call positions once the Index starts to show signs of rebounding. However, remember that the medium-term trend is to the downside and fighting the trend can be a dangerous proposition, especially with the Hang Seng slipping and sliding all over the place.