CHINESE investors, by and large, have been restricted to making money by betting that stock prices will go up. Now the nation's market regulators are about to expand so-called "short selling" that allows professional investors to bet that prices will go down.

"It's a game for the wealthy," said Wu Jing, a 47-year-old taxi driver with a pretty savvy sense of what are esoteric investment instruments.

It's not only a game for the wealthy but also for risk-takers. There's a lot of money to be made if the investor gets it right, and a lot of money to be lost if he doesn't. The unwary can lose their shirts very quickly.

Short-selling works like this. An investor borrows shares from a broker and then sells them, betting that the share price will drop and he can buy the shares back at a lower price when it comes time to return the borrowed stock to the broker. The risk? That the share price will go up, not down, and losses mount with every upward tick.

Short selling is used to hedge bets by some investors and for pure speculation by others.

China launched short selling - along with margin trading - on a trial basis in 2010, but the experiment was limited to some underlying stocks owned by brokerages. The expanded program will allow brokerages to borrow stocks and "re-lend" them to client investors.

There are generally two types of accounts at brokerages. One is the cash account, where you pay for shares you buy upfront. The other is a margin account, where the broker lends a client money, with interest, to buy shares and keeps the shares as collateral. The client is required to make a cash down payment, called "the margin." A margin account allows an investor to leverage his holdings by buying more shares than he actually has cash on hand to pay for.

Data from the Shanghai and Shenzhen stock exchanges showed that margin trading and short-selling transactions on the two bourses as of September 27 were valued at 72 billion yuan (US$11.4 billion), of which short selling accounted for only 2 percent of the total.

The China Securities Finance Corp, a state-owned intermediary body, has been set up to facilitate the instrument by borrowing cash or stocks from financial institutions such as banks, mutual funds and insurers, and re-lending them to brokerages for margin trading or short selling businesses.

In Western markets, short selling and margin trading have often been singled out as villains during times of market volatility or price crashes. However, analysts here said China's expanded program will inject more liquidity into the stock market and will help investors diversify their portfolios.

Wang Zelan, general manager of the margin brokerage department at China Galaxy Securities, said he expects the market volume of re-lending could reach 200 billion yuan to 300 billion yuan once the new mechanism is up and running. That compares with combined daily turnover of around 100 billion yuan on the Shanghai and Shenzhen bourses. "The re-lending mechanism will increase the circulation of capital and securities, and, therefore, boost the fluidity and vitality of the market," said Wang.

Hedging channels

Chen Yu, general manager at Shennong Capital Management, said short selling will multiply opportunities for investors to profit from the equity markets by providing hedging channels and enabling them to make money in a bear market.

Retail investors, however, won't be participating. Under current rules, only investors with trading account assets of at least 500,000 yuan can participate in short selling or margin trading.

According to the China Securities Depository and Clearing Corp, the number of individual investors holding shares worth of more than 500,000 yuan accounted for mere 2.1 percent of the market at the end of August.

"It puts us at a distinct disadvantage," said taxi driver Wu. "We can only bet on prices going up, while the privileged can make money from either increases or declines in share prices."

Short selling and margin trading do require a level of market sophistication usually lacking in most "mom and pop" investors.

In practical terms, short sellers need to be adept at identifying overvalued or speculative stocks, or ferreting out malpractices that might doom a given stock price. To some degree, that requires inside information and extensive market research.

The risks of short selling are high. Possible gains are limited to the original price of the stock, and maximum profit is achieved only when the price goes down to zero. There is no limit on the losses that can accrue - and sometimes accrue quickly.

"The re-lending business brings excessive profits along with higher risks," said Ma Ying, analyst at Haitong Securities. "It means you need good risk management and risk tolerance."

"Average investors in China can hardly control and bear such risk," said Cheng Yuyu, an analyst with Huatai Securities. "That's part of the reason why regulators have set high barriers to entry into the business."

Questions remain about how more expansive short selling may affect share prices.

Market fluctuations could increase, hurting unwary individual investors.

"Investors tend to borrow money and buy shares when they feel confident, which would push up the market, while they are inclined to borrow stocks and sell them when bearish sentiment dominates the market, adding to the downside pressure," said Wang Jianhui, deputy director at Capital Securities.

Chinese investor confidence is currently at low ebb. The stock market has been hovering around the low level seen in February 2009, which makes the market more vulnerable to shorting.

Publicized cases of insider trading, doggy financial disclosure and market manipulation have also conspired to chip away at investor confidence, feeding short sellers.

Retail investors, whose share purchases rely on a bull market to show profit, may find themselves in a weak position because those who can make money from a falling market can bring down stock prices in a short time, said Chen Lin, director of research at MyFP Wealth Advisory Co.

With greater imbalance between risk and reward, China's stock market is becoming more and more unsuitable for retail investors, Chen said.