China Trading Strategy (Backtest – FXI Strategy)

Last Updated on September 26, 2022 by Oddmund Groette

Globalization has made it possible for investors to tap into investment opportunities around the world, and as the second largest economy in the world, the Chinese stock market provides opportunities. But what is your China trading strategy?

You can also trade Chinese stocks listed on Chinese exchanges, especially the Hong Kong Exchange. However, you would have to open a brokerage account with an international broker with a presence in the Chinese market, such as Interactive Brokers. Alternatively, you can invest in mutual funds or exchange-traded funds (ETFs) that track the Chinese stock exchanges, for example FXI.

In this post, we take a look at how to trade Chinese stocks. At the end of the article, we present a backtested China trading strategy (FXI trading strategy).

How can you trade Chinese stocks?

Apart from trading the American Depositary Receipts (ADRs) of Chinese stocks listed on US exchanges, you can also trade Chinese stocks listed on Chinese exchanges, especially the Hong Kong Exchange. However, you would have to open a brokerage account with an international broker with a presence in the Chinese market, most likely Hong Kong. One popular broker that offers trading in the Hong Kong stock market is Interactive Brokers (is Interactive Brokers safe?).

An easier way to invest in Chinese stocks is to invest in mutual funds or exchange-traded funds (ETFs) that track the Chinese stock exchanges (please read our take on ETFs vs futures). These instruments don’t just offer you exposure to the Chinese stock market but also offer you a diversified portfolio by spreading out your investment across hundreds or even thousands of companies.

China ETFs

If you want to trade Chinese stocks we recommend the following ETFs:

  • FXI: Chinese large caps
  • MCHI: iShares China
  • YANG: Direxion Daily FTSE China Bear 3X Shares

There are any more ETFs, but these are the most liquid ones (FXI the most liquid and the one we trade ourselves).

How many Chinese stocks are there?

China’s three main stock exchanges host one of Asia’s largest collections of listed companies in terms of market cap. But how many Chinese stocks are there?

Well, it is difficult to know the total number of Chinese stocks, as they increase all the time. However, we can estimate that by checking the number of stocks listed on the three Chinese stock exchanges:

  • Hong Kong Stock Exchange: As of 2021, over 2,572 companies were listed on the Hong Kong Stock Exchange.
  • Shanghai Stock Exchange: The Shanghai Stock Exchange is the second largest stock exchange in the world in terms of capital raised. At the end of 2021, there are over 2,037 companies with a total of 2,079 stocks listed on the Shanghai Stock Exchange (SSE).
  • Shenzhen Stock Exchange: There are over 2,672 companies listed on the Shenzhen Stock Exchange, as of December 2021.

So, in total, there are 7323 listed stocks on the three Chinese stock exchanges. However, some of those stocks may have been listed on more than exchanges — for example, some mainland Chinese stocks listed on Shanghai Stock Exchange may also be listed on the Hong Kong Stock Exchange. To get access to Chinese stocks we recommend using Interactive Brokers.

What are the biggest Chinese companies or stocks?

Some of the biggest Chinese companies are as follows:

  • Tencent: This is a Chinese multinational technology and entertainment conglomerate and holding company headquartered in Shenzhen. It is one of the highest-grossing multimedia companies in the world based on revenue. It is also one of the largest video game companies in the world.
  • Kweichow Moutai: This is a state-owned enterprise, specializing in the production and sales of the spirit Maotai baijiu, together with the production and sale of beverage, food and packaging material, and the development of anti-counterfeiting technology. It is listed on the Shanghai Stock Exchange.
  • Alibaba: Alibaba Group Holding Limited is a Chinese multinational technology company specializing in e-commerce, retail, Internet, and technology. The company provides consumer-to-consumer (C2C), business-to-consumer (B2C), and business-to-business (B2B) sales services via web portals, as well as electronic payment services, shopping search engines, and cloud computing services.
  • ICBC: This is a state-owned commercial bank. With capital provided by the Ministry of Finance of China, it is ranked the largest bank in the world by total assets, with over US$4 trillion as of December 2020. It is considered a systemically important bank by the Financial Stability Board.
  • CATL: Contemporary Amperex Technology Co. Limited is a Chinese battery manufacturer and technology company founded in 2011 that specializes in the manufacturing of lithium-ion batteries for electric vehicles and energy storage systems, as well as battery management systems (BMS). It is the biggest lithium-ion battery manufacturer for EVs in the world.
  • China Construction Bank (CCB): It is one of the “big four” banks in China. Its headquarters is in Xicheng District, Beijing, but it has branches in major cities around the world. It is considered a systemically important bank by the Financial Stability Board.
  • Meituan: This is a Chinese shopping platform for locally found consumer products and retail services, such as entertainment, dining, delivery, travel, and other services. The company was founded in 2010 and is headquartered in Beijing. It operates different apps and websites for different services.
  • China Mobile: The company provides mobile voice and multimedia services through its nationwide mobile telecommunications network across mainland China and Hong Kong. It is the largest wireless carrier in China, with 945.50 million subscribers as of June 2021, making it the world’s largest mobile network operator by total number of subscribers. The stock is listed on the Hong Kong Stock Exchange.
  • Agricultural Bank of China (ABC): Also known as AgBank, ABC is one of the “Big Four” banks in China. It was founded on 10 July 1951 and has its headquarters in Dongcheng District, Beijing. It is considered a systemically important bank by the Financial Stability Board.
  • PetroChina: This is a Chinese oil and gas company. It is the listed arm of state-owned China National Petroleum Corporation, which is headquartered in Dongcheng District, Beijing. The stock is listed on the Hong Kong and New York stock exchanges.

However, keep in mind that the flux of the market is huge. Those companies “hot” today might be gone tomorrow. To better understand this we recommend reading our article do stocks outperform Treasury bills(?). In the stock market, very few companies contribute to the overall gains.

How is the Chinese economy?

The Chinese government is an authoritarian system, under the exclusive political leadership of the Chinese Communist Party (CCP), and consists of legislative, executive, military, supervisory, judicial, and procuratorial branches. There are no freely elected national leaders, and political opposition is VERY suppressed.

Please also consider the risk of being “canceled” – just like what happened to Russia when it invaded Ukraine. If China attacks Taiwan, the same fate could happen to China. The famous investor Kyle Bass has over many years argued that Chinese investors most likely will lose “everything” at one point in time.

However, the Chinese economy is presumably thriving, as the government gradually opened its market to foreign investment. China runs a socialist market economy that consists of state-owned enterprises (SOEs) and mixed-ownership enterprises, as well as a large domestic private sector and foreign businesses. It has the world’s second-largest economy when measured by nominal GDP, totaling around US$17.7 trillion (114.4 trillion yuan) in 2021, and since 2017, the world’s largest economy when measured by Purchasing Power Parity (PPP).

China stocks performance

Despite the “economic miracle” of China stocks have not performed well. Below is the performance of the Chinese ETF with the ticker code FXI:

China trading strategy (performance)
China trading strategy (performance)

Chinese stocks performed extremely well until 2007, but has since then returned nothing! Despite this, Chinese stocks offer good trading opportunities, something we’ll discuss in the rest of the article:

How to trade Chinese stocks: FXI trading strategy

Despite the poor performance of Chinese stocks overall, they are a great trading vehicle. We have for many years traded the ETF with the ticker code FXI. It’s volatile and has lots of liquidity, two of the most important factors in trading. It has also shown very strong tendencies to revert to the mean – which obviousuly is perfect for any mean reversion trading strategy.

China trading strategy no 1 (backtest – FXI trading strategy)

Let’s go on to backtest a China trading strategy with specific settings and trading rules. We use the above mentioned ETF with the ticker code FXI.

We use our monthly trading edge from July 2021 as an example:

  • This is a short strategy
  • We sell short FXI at the close.
  • The strategy has two trading rules: one seasonality and one measuring the price action.
  • The strategy covers at the open the next day no matter what (this is thus an overnight trading strategy).

The equity curve looks like this:

China trading strategy (short FXI trading strategy)
China trading strategy (short FXI trading strategy)

We argue this is a pretty good equity curve (what is equity curve?). The average gain per trade is 0.31% and the win rate is pretty high at 63% (why you want a high win rate strategy). The average winner is bigger than the average loser. Overall, the trading strategy metrics are pretty good.

The strategy can also be purchased on our single strategy page (strategy number 12).

China trading strategy no 2 (backtest – FXI trading strategy)

Let’s go on to backtest yet another short strategy in FXI. This strategy is using parts of the variables from our monthly trading edge of August 2021 (single strategy number 1). The monthly edge was a long trade, but we flipped it for FXI to make the opposite trading rule. The exit rule is based on an oscillating trading indicator.

This is how the equity curve looks like:

China trading strategy (FXI trading strategy - short)
China trading strategy (FXI trading strategy – short)

There are 256 trades and the average gain is 0.45%, the win rate is 60%, and the profit factor is 1.8 (what is profit factor?). We believe this is pretty good numbers. We plan to release the strategy a monthly trading edge later, please look at our shop and monthly trading club.

China trading strategy no 3 (backtest – FXI trading strategy)

Our last China trading strategy (FXI) is a long strategy. The strategy has two variables: one for defining a particular seasonality and one to define the trend (we believe seasonal trading strategies are the ones most likely to stand the test of time). We exit at the open the next day.

Let’s look at the equity curve:

China trading strategy (FX) - long strategy
China trading strategy (FX) – long strategy

There are only 44 trades but the average gain is a solid 0.97%.

China trading strategy no 4: All 3 strategies combined

Let’s see how our 3 China/FXI trading strategies have performed together as a portfolio of strategies (we allocate 100% of the equity to each trade):

China trading strategy (FXI)
China trading strategy (FXI)

There are 431 trades, the average gain is 0.5%, the win rate is 64%, CAGR is 11.5%, time spent in the market is only 20%, and the profit factor is 2.1. We believe these are solid numbers for strategies developed a few years back.

China trading strategy (FXI) – ending remarks

In this article, we backtested 3 different China trading strategies by using the ETF FXI. All of them perform well, and an added bonus is that two of the strategies are trading the short side. There is added bonus to having a China trading strategy: they add diversification to existing stock market trading strategies because it’s a lot less correlated than developed stock markets.

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