Chinese stocks ended lower on the first day of trading after the week-long Lunar New Year holiday amid concerns that soon-to-be-launched short selling in Shanghai will weigh on the bullish market sentiment.

Starting next week, overseas investors will be allowed to engage in short selling on a total of 414 stocks listed in Shanghai through the Shanghai-Hong Kong Stock Connect - a trading arrangement that allows mainland and Hong Kong investors to trade shares in each other's markets.

The introduction of short selling is being seen as an attempt by the securities regulator to lure more sophisticated international investors into the mainland's markets by offering them more hedging tools.

The initial impact is expected to be limited, however, as the daily volume of short positions on a stock will be capped at 1 percent and no more than 5 percent over 10 consecutive days, according to the Hong Kong Exchanges and Clearing Ltd.

But the bearish mood already began to spread as most shares in Shanghai and Shenzhen declined on Wednesday, led by insurance and brokerage stocks.

Overseas traders are already betting against Chinese shares as short interest in the largest US-listed exchange-traded fund tracking the mainland's stocks was 6.3 percent, up 0.1 percent from the end of last year, Bloomberg reported.

"There might be limited room for the indexes in Shanghai and Shenzhen to continue to rise and the markets will see fluctuations in the near term," Fang Lei, a strategist with Ping An Securities Co, said in a research note.

Fang said rising uncertainty is likely to persist throughout March as the positive liquidity factor gradually thins out with the country's general economic performance unlikely to present the market with any major surprises.

China's better-than-expected manufacturing activity in February, highlighted in HSBC's flash Purchasing Managers Index, failed to cheer investors on Wednesday.

The Shanghai Composite Index fell 0.56 percent while the Shenzhen Component Index retreated 1.53 percent after both indexes had gained for seven consecutive trading days before the holiday break.

Some analysts remained bullish on the fortunes of the A-share market, however, based on the likelihood of further interest rate cuts by the country's monetary authorities to shore up the economy.

It is widely expected that the People's Bank of China, the central bank, will cut the benchmark interest rate by 25 basis points and further reduce the reserve requirement ratio for banks in the first half of this year.

"The market is likely to continue to rebound in March with improved liquidity as slower growth and deflation risks prompt the central bank to further loosen monetary policy," Guodu Securities said in a report.

Investor confidence may also be given a boost from the upcoming two sessions of the National People's Congress, the top legislature, and the Chinese People's Political Consultative Conference, the top advisory body, during which key reform policies will be discussed, the report said.

[email protected]