If Foreigners Are Net Japan Buyers, Who's Selling?

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Latest data from Japan's Ministry of Finance (MoF) published on Thursday showed foreign investors remained net buyers of stocks last week – a period during which the country's equity market suffered its steepest single-day sell-off in two years.

So, who is behind the rout in Japanese equities, which have plummeted more than 12 percent over the past week?

According to market experts, the sell-off that began last Thursday after the benchmark Nikkei 225 came within a whisker of 16,000 - a key psychological level for the index - has been largely driven by domestic retail investors, alongside hedge funds.

"If you look at the foreign buying of Japanese equities, it didn't change, so that means it was a domestically driven sell-off," said Paul Grunewald, chief economist, Asia Pacific at Standard and Poor's Ratings Services.

(Read More: Nikkei - Stable Now but for How Long?)

Foreign investors were net buyers in the country's stock market last week, even though purchases of 27.4 billion yen ($271 million) were less than the previous week's net buying of 715.8 billion yen.

Optimism over Prime Minister Shinzo Abe's efforts to revive Japan's economy has lured previously cautious domestic investors back into the market in the recent months, contributing to the rapid rise in Japanese equities over the past six months.

"Japanese domestic investors are very important – it's a market that's driven by retail investors rather than institutional investors, which is different from the U.S. market which is mostly institutional," said Uwe Parpart, head of research at Reorient Financial Markets.

Individual investors accounted for almost 40 percent of trades by value for the week ended May 17, according to data from the Tokyo Stock Exchange, from around 30 percent at the end of March.

But recent exuberance in the stock market coupled with volatility in the Japanese government bond market has triggered caution among individual investors, said strategists.

"The Nikkei had a strong run; it pushed all the way through 15,000 approaching 16,000 in a short space of time. Profit taking and concern over instability in Japanese bonds is driving local investors to get out of Japanese stocks," said Stan Shamu, market strategist at trading firm IG Market.

(Read More: The Sun Will Rise: Why Investors Still Love Japan)

And, according to market watchers including Parpart, downside in the market is likely to continue in the near-term.

"We've seen a bit of a recovery in the market [this week], but there is no depth to it. We will get a 15 percent correction before we get back on track. That will be a healthy thing as there has been a lot of froth in the market," Parpart said.

The Nikkei 225 declined as much as 3 percent on Thursday falling below the 14,000 level to trade around 13,923 in the morning session.

By CNBC's Ansuya Harjani.