A steep rise in inflation coupled with the US slowdown has seen mayhem rule the Chinese markets, writes Clifford Coonan.

CHINA'S key Shanghai stock index registered a 9.29 per cent increase this week for its biggest daily rise in six years after the government lowered stamp duty in an attempt to stop an alarming slide in share prices in the past six months.

A vertigo-inducing rise in inflation coupled with the slowdown in the US economy has seen mayhem rule the Chinese markets of late. Concerned about stability, the government slashed trading tax from 0.3 per cent to 0.1 per cent.

It took just two years for China's blue-chip share index, the Shanghai composite share index, to rise from 1,000 to 6,000 points, but it has taken only around two months for it to tumble from 6,000 to below 3,000, before this week's return to 3,500.

The 500 per cent rise came as millions of new investors signed up every day. Champagne corks popped as the latest formerly creaking state enterprise unveiled its new sleek self for public listing. However, the bubble on China's stock market has now well and truly burst and the country's 150 million share investors are waking up to their worst hangover ever.

There are concerns about oversupply of stocks in domestic markets and this week regulators also introduced restrictions on the sale of unlocked shares, which analysts read as a sign that the market has fallen as far as the government is prepared to tolerate.

"The timing of the stamp duty cut suggests that 3,000 points may be a psychological bottom line for policymakers," Peng Cheng, an economist at Citi China, told the Xinhua news agency.

"The government had been patient in waiting until the market correction was more than 50 per cent before taking action," Peng added.

The market slide in the last half-year has mostly hit China's army of small investors, who last year piled into the share market, ignoring market analysts' and government regulators' warnings of a bubble.

"To leave quietly, or to stay bravely, that is the question," is how one anonymous investor put it in a web posting.

China's new investment community reflects the demographic that has benefited most from the 66 per cent expansion of the Chinese economy in the past five years - the young and upwardly mobile.

Fifty-seven per cent of investors on Shanghai's stock market are retail investors, compared to 20 per cent in New York or 30 per cent in Hong Kong. The average investor in A shares is 35 years of age, with 90 per cent of investors under 50. And 40 per cent of investors on the Shanghai stock exchange have been investing for less than a year.

This lack of experience has led to increased volatility. There are reports of people picking stocks at random, using lucky numbers or consulting fortune-tellers to buy shares. And rather than buy a stable portfolio of shares to spread the risk, they stick to one or two stocks. A survey this month by the Kapronasia group showed a lack of diversification in portfolios, with 65 per cent of investors holding between one and three stocks, a high-risk strategy in a volatile market.

Conditioned to believe in old-school Communist interventionism rather than New China free market thinking, many investors believed there was no way the stock market could fall before the Olympic Games in August.

For many young Chinese buying stocks has been a way of boosting disposable income rather than helping to build a long-term savings plan. They needed to get out of investment models such as property investment, which had become overregulated and, with too many new buildings, oversupplied.

In the long term, the outlook for the Chinese market seems fairly healthy, and 3,500 points is 2,500 points higher than two years ago. It is a question of whether nerves will hold.