On June 12, we saw carnage in the Chinese stock markets. The Shanghai composite has since tumbled in just three weeks, 30% from its seven-year high, wiping out more than $3 trillion worth of wealth.
What is even more curious is the stock market boom starting in June 2014, which saw the index surging up 110% to a seven-year high of 5166 points in June 2015, just before the crash.
Does this irrational exuberance in the Chinese stock markets make sense, especially with arguably ugly economic figures?
The fear of losing out in the great bull run has caused many young Chinese investors to employing excessive leverage. Over the past few months, margin finance has risen from a mere 1 trillion yuan to 1.46 trillion yuan in march 2015.
And there we have it. The equation explaining the bull run in the Chinese market: Increase in retail investor participation + increase in leveraged stock trading.