A new mechanism designed to prevent extreme share price volatility is being introduced in Hong Kong.

HKEX, which owns the city’s stock market and clearing infrastructure, said a volatility control mechanism (VCM) will go live at the start of next week.

Many international exchanges have a mechanism to control extreme price volatility as part of G20 and IOSCO reforms to deal with systemic risks.

“In the case of HKEX's VCM, a simple and light-touch model was chosen after extensive consultation with market participants, with a view towards protecting investors while minimising trading interruption,” HKEX officials wrote in a statement.

The VCM is applied at the individual security level to Hang Seng Index (HSI) and Hang Seng China Enterprise Index (HSCEI, or H-shares Index) constituents - currently 81 securities.

An attempt to trade a security covered by the VCM at a price more than 10 per cent away from its last traded price 5 minutes ago will trigger a cooling-off period of 5 minutes where trading of the security can continue but within a band.

"The cooling-off period in the VCM mechanism alerts the market, provides a short time window allowing market participants to reassess their strategies and positions, and helps re-establish an orderly market at times when there is abrupt and drastic price movement for the security concerned," said Roger Lee, HKEX's Head of Markets.

"The VCM is not intended to limit the ups and downs of stock prices due to fundamentals, and it should not be mistakenly seen as a trading halt mechanism or confused with the daily price limits that some markets use to keep a stock's trading within a specific price range," Lee added. 

"In cases of price movement driven by fundamentals, there is a 5-minute cooling-off period under the VCM after which trading can continue for the rest of the session without further intervention.

"Given that the VCM is designed to safeguard the market from extreme price volatility arising from major trading incidents, market participants should not expect it to take effect very often and should continue to exercise due care and remain cautious in their trading."