Crypto and Stock Market Drop: The Sixth Blade—Killing Liquidity

Continuing to discuss the “Seven Knives” that cut down the stock market,

The first five episodes covered cutting valuations,

cutting logic,

cutting performance,

cutting expectations, and cutting sentiment.

Today, I want to talk about the sixth knife—cutting liquidity.

Liquidity is mainly drained in some small-cap stocks and certain industries,

or when the market as a whole is short of money,

even if stock valuations are already very cheap,

and the investment logic hasn’t changed,

but no one is willing to take over,

and the stock price can only keep falling.

Here, I am not discussing value investing,

just sharing market behavior with everyone.

Draining liquidity in the market is a rather insidious situation,

often accompanied by a slow decline,

and it’s very easy to suddenly plunge in volume and price.

Many people think that a sharp drop with low volume means the end of the trend,

but in most cases,

it’s actually because there are no buyers.

This situation often manifests as continuous decline with decreasing volume,

lacking liquidity.

It’s not that the company itself is bad,

nor that the industry logic is flawed,

but simply that no one is willing to buy.

This usually occurs in the late stages of a bear market,

even if you want to sell stocks, you can’t sell them,

especially for investors with large capital,

this dilemma is even more obvious.

The so-called draining liquidity,

means the market’s buy orders are exhausted,

trading volume drops sharply.

In a bear market,

you often see trading volume only about one-tenth of that in a bull market,

because funds are withdrawing from the stock market.

In a bull market,

the high trading volume is due to large inflows of capital.

In a bear market,

many investors, even if trapped,

stop trading,

and even neglect managing their accounts.

People tend to avoid pain,

and choose things that make them happy.

Some investors, to escape pain,

simply leave the stock market forever.

As a result,

if someone wants to sell stocks but can’t,

they can only keep lowering the price to sell,

causing the stock price to fall rapidly,

sometimes even dropping to limit down for consecutive days,

which often happens with funds,

causing retail investors and some larger holders to suffer losses.

Draining liquidity differs from cutting valuation,

cutting logic, and other judgments based on value and expectations,

it is more about trading, structural, and capital issues.

Essentially, good companies have no buyers,

bad companies have no rescuers.

From the perspective of trading volume,

the market’s liquidity problems are reflected in: not only low trading volume,

but also a cliff-like drop in both stock price and volume,

several days of insufficient volume,

large bid-ask spreads,

and big black candlesticks without volume.

At the same time,

capital outflows are concentrated,

mainstream institutions,

hot money,

ETFs, etc., all redeeming shares during bear markets,

everyone is selling off,

but no one is taking over.

Or when a whole sector recedes,

related themes fall out of favor,

companies become unnoticed,

and the large inflow of funds previously entering rush to exit.

Additionally,

frequent major share reductions by major shareholders or pledge defaults,

also cause market fears of excessive selling pressure,

leading major shareholders to sell early before reducing holdings,

and investors to exit in advance.

Another point,

stocks with very small market caps,

are generally not recommended for retail investors.

These obscure small-cap stocks,

are difficult for large funds to enter,

unless their investment logic undergoes a major change.

Small and medium-sized companies,

especially some private firms,

are more likely to cook their books.

Once exposed,

nobody wants to take over,

because it’s unclear how deep the fraud goes,

which easily leads to liquidity exhaustion.

Small-cap stocks with tiny market caps are riskier,

and should be avoided casually.

These stocks may be overvalued,

with low profits,

and even profit authenticity is hard to judge.

Draining liquidity is common in some micro-cap stocks with leverage,

any slight disturbance can cause a blow-up,

and the stock price becomes severely distorted.

When stock prices rise sharply,

some holders think it’s good,

but when they want to sell, they can’t,

and selling causes the price to fall,

making it impossible to escape,

holding such stocks is very painful.

For example, a stock worth 10 million,

if it has high daily trading volume,

can probably be sold easily.

But if trading volume is sparse,

holders can only sell little by little,

and the price keeps falling daily,

holding such stocks is a real pain.

Sometimes,

the company’s performance is fine,

but large holders, due to their own capital needs,

can only sell off gradually,

causing a divergence between stock price and performance.

There are also cases of backdoor listings,

after hot topics fade,

like the once popular ChatGPT concept stocks,

NFT concepts, etc.,

once funds withdraw,

no one is willing to take over,

because retail investors find it hard to absorb such large-scale sell-offs.

Retail investors usually wait for the stock to be pumped up,

and to be “fooled” by various stories before entering,

but for declining stocks,

most retail investors won’t buy in.

When the market’s favored themes lose popularity,

it indicates that retail investors are probably crowded in,

these investors don’t look at fundamentals,

they don’t see value,

and once disappointed and losing money,

they choose to sell to reduce pain,

and at this point, no one is buying,

causing the artificially supported stock prices to inevitably collapse.

There are also some Hong Kong concept stocks,

where some companies’ financial statements look good,

but no one is willing to rescue.

For example, recently some US-listed companies,

market trading is inactive.

Additionally,

high pledge defaults can trigger liquidity drain,

like Kangmei Pharmaceutical,

Breeze Group,

once forced to liquidate,

banks, brokerages, and others holding positions will demand large-scale sell-offs,

but no one dares to take over,

especially after negative news breaks.

At this point,

if the company’s business is actually good,

there might still be a turnaround,

Luckin Coffee is a typical example,

despite previous financial fraud,

its operations later improved.

However,

most companies can’t withstand such blows.

For instance, Kangmei’s financial fraud and pledge defaults,

immediately caused liquidity collapse,

and some ST stocks are abandoned by the market,

with continuous limit-downs on no volume,

this is especially common among small stocks on the ChiNext.

These small stocks are not held by institutions or hot money,

and are very prone to falling into an endless dead cycle.

I don’t participate in this kind of investment,

just sharing related signs of liquidity drain and some risks,

for example, one situation is,

when a stock’s daily trading volume is less than 1% of its market cap,

it indicates poor liquidity.

Poor liquidity doesn’t necessarily mean the company is bad,

but most of these stocks tend to have poor performance.

If trading volume remains this low,

and there’s no capital speculation,

then it’s even worse,

investors are likely to be trapped forever,

and can’t sell at all.

Stocks with such low volume and below 1%,

and poor performance,

are easily triggered into a stampede with any disturbance,

because many are still trapped inside,

and a decline is often a no-volume drop,

with very low turnover,

and little market attention.

Another issue is the so-called order book depth gap,

excessive sell orders,

and easy to be driven,

any small movement can cause a flash crash.

This may be due to someone rushing to sell stocks,

for example, owing money,

and having no choice but to sell,

maybe forced liquidation by brokers,

or creditors demanding liquidation,

even without buy orders,

they can only sell at market.

Therefore,

when stock prices plummet,

don’t always assume it’s just market manipulators dumping,

some of it is indeed due to poor liquidity,

the company itself is not good,

and no one wants to buy.

Otherwise,

if it’s a good company,

even with liquidity issues,

when the price is at the bottom,

there will still be buyers.

Sometimes,

after a sharp decline,

the stock suddenly surges on volume at the bottom,

if the company’s fundamentals are good,

it could be that those who have been optimistic are finally forced to liquidate,

and others take over,

and the stock may then rise sharply,

this is the opportunity brought by liquidity problems.

But for stocks draining liquidity,

retail investors without enough patience,

should avoid them as much as possible,

these are the so-called “zombie stocks.”

Of course,

if you have patience, you can consider them,

but I (Mr. Jin) don’t have enough patience,

and I won’t touch such stocks.

Relatively speaking,

I buy less,

like China Resources Pharmaceutical in Hong Kong stocks, which is a good example,

low valuation and decent financials,

but it just doesn’t rise,

because many foreign funds are withdrawing from Hong Kong stocks.

So, such stocks should match your personality,

if investors lack patience,

even if the stock has certain value features,

it’s not recommended to focus on them.

For value investors with patience,

a company’s stock is cheap, undervalued,

and has good financials,

but you need to have capital to follow,

to have a margin of safety,

so the stock price can go up.

After all, buying stocks is for making money,

can you wait 5 years or even 10 years?

If you lack this patience,

you might waste a lot of time and effort.

Just like some people judge liquidity by trading volume,

thinking that high volume means good liquidity.

For example, looking at volume-price relationships,

some believe that high volume indicates good liquidity,

which makes sense,

but don’t forget that volume can be manipulated,

high volume might be achieved through wash trading,

but low volume can’t be artificially changed.

Low volume definitely indicates poor liquidity,

high volume, while not always good,

at least doesn’t look too bad,

and indicates relatively healthier liquidity,

but the two are not simply equivalent,

nothing is absolute.

Additionally,

when liquidity is poor,

if the buy-in volume is large,

you must pay attention to stop-loss and take-profit,

and not just resist blindly.

In summary,

compared to the previous discussion on cutting valuation and logic,

cutting valuation mainly looks at valuation levels,

cutting logic considers whether there are new stories to support,

and draining liquidity, for investors with large capital,

once there are no takers,

it’s hard to escape.

Especially for those who like to speculate on small caps,

thinking they can control the market,

they often find themselves trapped,

especially with poor-performing junk stocks,

be extra cautious.

For small caps,

from a value investing perspective,

some are still feasible.

Like Zhou Shengsheng,

which is quite good from a value investing standpoint,

with good dividend performance.

Tan Mujiang mentioned by Yang Tiannan is similar,

with low P/E ratio,

good business development,

but poor liquidity,

hard for large funds to enter,

because after buying, they have to consider selling,

and its growth potential isn’t strong,

easily falling into a liquidity trap.

I’m not specifically discussing value investing itself,

just want to say,

any value investing approach,

must consider whether your investment style matches your personality,

that’s the most important.

It’s like tools need to fit the user,

choose what suits you,

there’s no absolutely correct tool or investment method.

Value investing can be achieved in various ways,

some diversify,

some prefer concentrated investments,

some excel at deep research,

others invest based on market sentiment changes,

each approach has its own merits.

Like Buffett’s concept of the circle of competence,

and margin of safety,

he also said, "If you aren’t willing to hold for 10 years,

don’t hold for 10 minutes,"

but some say Buffett’s investments are usually not held longer than a year,

the truth of this and the background behind it are uncertain.

In short,

find an investment approach that suits your personality.