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Photographer: Qilai Shen/Bloomberg Photographer: Qilai Shen/Bloomberg

The way Liu Xiaozhen tells it, the only way to truly understand China’s stock market is by learning the tactics of traders who routinely manipulate it.

QuickTake China’s Managed Markets

“We need to dance with the wolves,” says Liu, the chief executive officer at Qingdao Langwang Investment Consulting Co., a producer of online video seminars for stock investors in China’s eastern Shandong province.

For a one-time payment of 6,800 yuan ($1,050), Liu’s firm provides a crash course on stock manipulators in China: how to anticipate their targets, how to spot their trades and -- most importantly -- how to profit by following in their tracks. The three-month class is one of at least 100 across the country that promise insight into Zhuang Jia, a local term for market manipulators that portrays them as holding the upper hand.

The courses, along with hundreds of books on the subject, show how law-abiding investors are adapting to a market that even China’s state-run media acknowledge has become rife with manipulation. Instead of avoiding suspected Zhuang Jia targets, many of the nation’s 97 million individual investors actively seek them out -- hoping to ride the artificial gains in manipulated shares and sell before they inevitably collapse.

“If you want to make a quick buck from the stock market, you’d better look for stocks with manipulators,” explains Chen Yifeng, a 37-year-old accountant at a state-owned company in Shanghai who has about 100,000 yuan of his personal portfolio invested in local shares. “You just need to pull out faster than them.”

That piggy-back strategy, while completely legal, is magnifying the challenge for Chinese policy makers as they try to improve the international image of a $7.2 trillion stock market where valuations often appear detached from economic fundamentals. Global money managers cut their holdings of mainland shares by about 5 percent in the first nine months of 2015, even after authorities made it easier than ever to bring money into the country.

Chinese securities regulators are hoping to tackle the problem at its source. Over the past few months, they’ve escalated a crackdown on market manipulators, ensnaring some of the the nation’s most high-profile money managers and announcing more than 2 billion yuan of fines and confiscated gains. That comes after authorities more than doubled the pace of manipulation investigations in the first half from a year earlier.

QuickTake China's Managed Markets

The regulatory focus on manipulation “is a long overdue policy measure,” said Gan Jie, a professor of finance at the Beijing-based Cheung Kong Graduate School of Business. “This isn’t the first time authorities have tried to crack down, but in terms of scale it is large. This is good for the stock market.”

The Shanghai Composite Index rose 0.9 percent at the close

Multiple Manipulators

Gan says the most common form of manipulation in China is the classic “pump and dump” scheme, where the perpetrators establish positions in a stock and promote it to outsiders, seeking to inflate the share price before selling out. In some cases, multiple manipulators team up to trade shares among themselves, creating an illusion of growing investor demand that’s designed to attract momentum-chasing speculators, according to Oliver Rui, a professor of finance and accounting at China Europe International Business School in Shanghai.

China’s market is particularly vulnerable to such schemes because it has so many unsophisticated investors, Gan said. Individuals account for more than 80 percent of trading on mainland exchanges, while one university survey showed that more than two-thirds of the nation’s new investors at the end of 2014 hadn’t received a high-school level education.

While manipulation cases in developed countries like the U.S. often revolve around penny stocks with tiny market values, Chinese authorities have punished traders for targeting multi-billion dollar companies this year.

The China Securities Regulatory Commission levied a 19.9 million yuan fine in September on Ye Fei, one of the country’s most well-known hedge fund managers, after saying he manipulated five stocks including Beijing Xinwei Telecom Technology Group Co. The developer of network equipment has a market value of 75 billion yuan, on par with Alcoa Inc., the biggest U.S. aluminum producer.

Ye, the general manager at Yitian Investment Co., said he used "inappropriate methods" when trading shares in May and June, according to a letter to shareholders published on Yitian’s website in September. Ye couldn’t be reached for comment and a Yitian employee, who wouldn’t give his name, declined to comment when contacted by Bloomberg News.

This year’s most high-profile target of China’s manipulation crackdown was Xu Xiang, who ran some of the country’s top-performing hedge funds as the head of Zexi Investment in Shanghai. Xu was detained in November and police froze $1 billion of shares in listed companies tied to the money manager. Efforts to contact him for comment have been unsuccessful.

Investigations Increasing

While the CSRC doesn’t publish estimates on the prevalence of stock manipulation, it does release figures on manipulation cases pursued by regulators. The latest data show 31 investigations in the first half, versus 15 for all of 2014 and eight in 2013. In October, regulators said they had prosecuted 12 market manipulation cases with fines and confiscated gains totaling 2 billion yuan.

In a response to questions from Bloomberg News on Dec. 18, CSRC spokesman Zhang Xiaojun said that data on market manipulation cases for the second half will only be compiled at year-end. He said the CSRC has teams at branches across the country who monitor for signs of misconduct, including stock manipulation, without providing specifics.

Market manipulation in China is probably widespread in part because the market is still in the early stages of development, according to Rui, the finance professor at CEIBS in Shanghai. He compared the country to the U.S. during the 1920s, when “pump and dump” syndicates were common and the investing public often tried to benefit from the resulting share-price gains.

No Meat

Today’s mentality in China also has echoes of 1990s Japan, where reports of manipulation routinely showed up in financial tabloids and libraries were stocked with books on how to trade in manipulated shares, known locally as “shite kabu.”

While the popularity of piggy-back trades has diminished in the U.S. and Japan, those markets are by no means free of concerns about manipulation. Spoofing, when a trader places orders they have no intention of filling to move markets in their favor, has come under worldwide scrutiny this year as the rise of computerized trading made the bait-and-switch scheme more effective.

Of course, not all individual investors in China are chasing after manipulated stocks. Zhang Kai, a 27-year-old consultant at a financial firm in Beijing, sold his personal equity holdings in June in part because he thinks amateur traders will struggle to make much money in shares where Zhuang Jia are active.

"It’s possible for individual investors to enjoy some soup if they follow the Zhuang Jia, but they can never eat the meat in the end,” he said.

Market Crash

China’s state-run media began drawing attention to the manipulation problem late last year, with a November article in the official Xinhua News Agency saying the market had moved into a "New Zhuang Jia Stocks Era.” The piece warned that manipulators were using Internet posts and online messaging services to drive up share prices before dumping holdings on individual investors.

Policy makers stepped up their rhetoric against manipulators after a crash this summer that erased $5 trillion of stock-market value. The CSRC organized a special probe into the issue during the height of a selloff in July, spurring speculation that authorities were seeking to deflect blame for a bust that many analysts say was fueled by lax regulation of leveraged investors.

Finding scapegoats is probably one goal of the crackdown, but it’s also part of the government’s long-term effort to professionalize the stock market and lure more international investors, according to CEIBS’s Rui. If China wants to achieve its ambition of turning the yuan into a global currency, policy makers will have to convince overseas fund managers they can keep market abuses to a minimum.

“It’s difficult for foreign investors who manage funds to justify jumping in” when the stocks they buy could be subject to manipulation, said Andy Xie, an independent economist in Hong Kong who previously worked for the World Bank and Morgan Stanley.

Wolf King

Changing investor attitudes will be difficult. While the CSRC says its public announcements on manipulation fines and investigations help educate investors on the dangers of Zhuang Jia, a search on online bookstore Dangdang.com returns more than 200 titles on how to find, follow and ride the coattails of stock-market manipulators.

"Death of Zhuang Jia" by Chen Siwen Source: Hangzhou Blue Lion Cultural & Creative Co., Ltd.

At Langwang, the investment seminar firm whose name translates to “wolf king,” students learn to track rapid price and volume changes that deviate from the broader stock market. Those are tell-tale signs of manipulation, according to Liu, the firm’s CEO. He says the best way to piggy-back on the gains is by building a “trial” position with a stop-loss order designed to limit damage if the stock reverses. If it rallies at least 5 percent, Liu suggests adding to the position.

“Stocks backed by major players and manipulators tend to perform much stronger,” Liu said. “The regulatory crackdown will certainly have some impact, but market manipulation will continue. It’s inevitable.”