How and Why the Chinese Shanghai Index could implode ...

This week, the Shanghai Composite Index has maintained its bubble trajectory angle, and if the angle continues to hold, the Shanghai will hits its 12 year major resistance in the latter half of next month.

Why is the Shanghai continuing to move up at such an incredible pace?

Because of supply and demand of investors.

From the supply side, over 10,000,000 Chinese citizens opened new stock trading accounts during the past 4 months. Last week ... over 1,000,000 opened new stock trading accounts.

No matter how you calculate it, that has been an average of 1 million new investors per week for 13 straight weeks in China.

This week, I had a discussion with a Hedge Fund manager about it. I asked, "How long do you think the Chinese market can go up by adding 1 million investors per week?"

His answer was, "Practically forever ... because they have over 1.3 BILLION people".

Logic versus REALITY ...

Logically, it seems to make sense. They have 1.3 billion people. At 1,000,000 per week, it would take 25 years for every Chinese person to have a stock trading account.

But, a statistical analysis shows a DIFFERENT reality for this reason ...

An implosion has nothing to do with how many people live in China. An implosion has everything to do with the Week-over-Week average number of NEW investors moving into the market ... and right now, the average has been 1 million per week for 13 weeks. They can't seem to move above that average, and part of is has to do with how many Chinese can continue to mortgage homes and draw cash our from credit card accounts.

The reality is, that if a universe adds 1,000,000 to its base every week, then the growth rate of the base continues to diminish at a rapid pace.

Consider this: In the first week, 1 million open a trading account. The second week, another million open a trading account. What was the increase in the size of the new trader pool in week 2? The answer: 100%

Now let's go to week number 6. At this point, there has been a total of 5 million new traders added to the pool (at a rate of 1 million per week.) Now, at week six, another million are added. What was the increase in the size of the new trader pool in week 6? The answer: 20% (1 million new divided by 5 million existing accounts.)

This is now the 14th. week since the new trading accounts have been reported. So, if another million are added this week, then this week would have only increased the pool size by 7.14%, a far cry from the 100% added in week 2.

Below is a chart to show you how the percentage of the investor pool size decreases even though 1 million is added every week.

If you look at the chart, you see how the first 5 weeks astronomically increases the size of the pool with a fast growth rate.

The red bar on the chart is week number 20. At week 20, another 1 million only adds 5% to the size of the pool.

The point is this ...

Every time someone in China gets a second mortgage, and draws his charge card credit down for cash to use in the stock market, he has tapped the Big Portion of his assets/credit. The only way to get new money for the stock market after that is from the left over discretionary income from his monthly wages ... not much in comparison to his initial amount.

So, in this Ponzi scheme of things, the 13,000,000 that had trading accounts relied on the new 1,000,000 to buy their stocks and drive the price up higher so that they could make their expected get rich profits.

Here is the big question: At what point does the pool get too large, where another new 1 million investors is now too small an amount to keep the overly large base of investor holdings from moving up?

At week 52 on the chart, the new 1 million addition of investors only increases the total investor base by 1.92%. In week thirty three, 3.03% of new investors are added to the base.

Here is the next big question: What happens, if in week thirty three, 6% of all the investors decide to take profits?

Let's start the answer with what would have happened in week 2 when 100% new investors were added. 100% buy and 6% sell. Assuming the average investor amounts are the same, then the market would have still had 94% new money inflows.

Now, lets go to week thirty three. What happens when 3% buy and 6% sell? The selling outpaces the buying by 2 to 1 and the market goes down.

The point is, that as time goes on, the leverage shifts from a bullish low-risk condition, to a high-risk bearish condition. When we get too far out on the curve of the chart I posted above, there will be a point where people can't bail out of the market without it imploding to the downside.

Please Note: We do not issue Buy or Sell timing recommendations on these Free daily update pages. I hope you understand, that in fairness, our Buy/Sell recommendations and advanced market Models are only available to our paid subscribers on a password required basis. Membership information