DEFINITION of 'SSE Composite'

The SSE Composite, which is short for the Shanghai Stock Exchange Composite Index, is a market composite made up of all the A-shares and B-shares that trade on the Shanghai Stock Exchange. The index is calculated by using a base period of 100. The first day of reporting was July 15, 1991.

The composite figure can be calculated by using the formula:

SSE Composite

BREAKING DOWN 'SSE Composite'

The SSE Composite is a good way to get a broad overview of the performance of companies listed on the Shanghai exchange. More selective indexes, such as the SSE 50 Index and SSE 180 Index, show market leaders by market capitalization.

With a population of over 1.3 billion and a growth rate over the past two decades that saw the country climb eight spots to second in the world in terms of GDP, China is an economic force. However, the country's stock market volatility has highlighted that, while China is a world power, it is not through with its growing pains.

Volatility in the SSE Composite

The SSE Composite is notoriously volatile. As an example, between November 2014 and June 2015, the SSE Composite shot up more than 150%, as the state-run media outlets talked up Chinese equities and encouraged inexperienced investors to buy them. Then, in the three months following that peak, the index lost more than 40% of its value. Companies suspended trading, short selling was essentially outlawed and the government intervened to support the market.

One of the biggest factors in this stock market correction was the lack of experience that China had in dealing with a stock market. The U.S. stock market, for example, has learned from past market crashes and corrections. Although far from perfect, the various exchanges have methods of slowing the market to allow for trading during falling prices while subtly pushing back against the all-out panic that can be disastrous.

The most obvious measure are the circuit breakers that kick in when the market plunges too fast. At the time, China only had a mechanism by which a company could suspend trading for an undefined period of time worked out between the company and the regulator. The stock market circuit breakers on the New York Stock Exchange (NYSE), by contrast, are not company specific and are designed to allow investors to catch their collective breath through temporary halts. (There are situations where the NYSE does suspend trading of a particular stock, but these are defined situations.)

This lack of defined market failsafes in China led to an ad hoc approach of whatever the government decided. And that left the door open to cutting interest rates, threats to arrest sellers, strategic trading suspensions and instructions to state-owned enterprises to start buying.

Another factor contributing to volatility in the SSE Composite and Chinese stocks in general is the lack of stock market players. China's stock market is relatively new and mainly made up of individuals. In most mature stock markets, the majority of buyers and sellers are actually institutions, when measured by volume. These big players have risk tolerances that are far different from the individual investor. Institutional buyers, particularly hedge funds, play an important role in maintaining liquidity in the market and shifting risk onto entities that can usually handle it. Even with those big players, things can and often do go wrong. That said, a market dominated by individual investors - particularly a large amount of individual investors trading on margin - is bound to see overreactions on the way up and the way down.

The role of the Chinese government is intertwined with the maturity issues the Chinese stock market faces. Governments intervening in the stock market is nothing new, but the eagerness with which the Chinese government jumped into the market troubled many. Most countries put off intervening until it is clear a systemic meltdown is unavoidable. However, the Chinese government felt the need to intervene strongly in 2015, perhaps because its policy decisions helped build up the bubble in the first place. This also set a hands-on precedent for future market events, which undercuts free market forces. The potential result - a Chinese stock market that is highly regulated to fit government ends - is a less attractive market for international investors.

China's Failed Experiment With Circuit Breakers

While the SSE Composite regained some ground between late September and late December of 2015, the index turned sharply lower heading into 2016. On Jan. 4, 2016, the Chinese government put a new circuit breaker in place in an attempt to add stability to the market by avoiding huge drops like the ones the SSE Composite suffered in 2015.

Also known as a trading curb, circuit breakers have been implemented in stock markets, and other asset markets, around the world. The intention of a circuit breaker is to halt trading in a security or market to prevent fear and panic selling from collapsing prices too quickly and without a fundamental basis, and spurring more panic selling in the process. Following a large decline, a market may be halted for a number of minutes or hours, and then resume trading once investors and analysts have had some time to digest price moves and might perceive the sell-off as a buying opportunity. The goal is to prevent a free fall and balance buyers and sellers during the halt period. If markets continue to fall, a second breaker may trigger a halt for the rest of the trading day. When a halt occurs, trading in associated derivative contracts, such as futures and options, is also suspended.

Circuit breakers were first conceived following the stock market crash of Oct. 19, 1987, also known as Black Monday, when the Dow Jones Industrial Average lost nearly 22% of its value in a single day, or half a trillion dollars. They were first implemented in the United States in 1989, and were initially based on an absolute point drop, rather than a percentage drop. That was changed in updated rules put into effect in 1997. In 2008, the Securities and Exchange Commission (SEC) put into effect Rule 48, which allows for securities to be halted and opened more quickly than a circuit breaker would allow under certain circumstances before the opening bell.

In the United States, for example, if the Dow falls by 10%, the NYSE can halt market trading for up to one hour. The size of a drop is a measure that will determine the duration of the halt. The larger the decline, the longer the trading halt. There are other circuit breakers in place for declines of 20% and 30% in a single day. There are similar breakers in effect for the S&P 500 and Russell 2000 indices as well, and for many exchange-traded funds (ETFs). Global markets, too, have implemented curbs.

The goal of a circuit breaker is to prevent panic selling and restore stability among buyers and sellers in a market. Circuit breakers have been used a number of times since their implementation, and they were crucial in stemming an outright market free fall after both the dotcom bubble burst and the fall of Lehman Brothers. Markets did continue to decline after those events, yet the selling was much more orderly than it otherwise could have been. However, the situation with China's circuit breakers was much different.

The circuit breakers enacted by the Chinese government on Jan. 4, 2016, stated that if the benchmark CSI 300 index, which is made up of 300 A-share stocks listed on the Shanghai or Shenzhen Stock Exchanges, falls 5% in a day, trading would be halted for 15 minutes. A 7% decline would trigger a halt in trading for the rest of the trading day.

That very day, the index fell 7% by early afternoon and the circuit breaker was triggered. Two days later, on Jan. 8, 2016, the index dropped more than 7% in the first 29 minutes of trading, triggering the circuit breaker for a second time. Chinese regulators announced they were suspending the circuit breakers, just four days after they had been put in place. They said the suspension was meant to create stability in equity markets; however, the inclusion of such circuit breakers was originally meant to maintain stability and continuity in markets. While removing the breakers entirely means a panic-driven free fall in prices can occur without hindrance, free market advocates argue that markets will take care of themselves and say trading halts are artificial barriers to market efficiency.

The SSE Composite ended up bottoming in late January 2016, roughly 50% below its June 2015 peak. The index, while still volatile, began a more measured advance compared with the 2015 run-up, rising about 30% over the next 20 months.

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