SINGAPORE/SEOUL, July 29 (Reuters) - South Korean stocks plunged for a second straight session on Wednesday as Asia's sparkling AI-fuelled rally turns into a record-breaking rout that is torching small investors.

The benchmark KOSPI index dived as much as 12.6%, which on top of a nearly 11% slump on Tuesday has the market tracking for a record two-day fall and a drop of more than 40% from a peak struck little more than a month ago.

Volumes were light, suggesting buyers have evaporated from what just weeks ago was the hottest trade in global markets - buying the chipmakers raking in cash from AI investment.

Much of that buying was done by small-time investors using borrowed money to increase their exposure, and that dynamic, which accelerated stocks higher in the rally, is exacerbating the selloff as brokers forcibly shut down losing positions.

"It's certainly a very crowded trade which is being unwound," said Frank Benzimra, head of Asia equity strategy at Societe Generale in Hong Kong.

"If you look at what is falling in the market, it has been the stocks in which you have the most leverage."

Shares in SK Hynix, which reported a six-fold earnings jump in the morning, were down 16% by mid-afternoon. Samsung Electronics stock dropped 9.8%.

The two chipmakers represent more than half of the market capitalisation of the KOSPI and have exerted substantial influence over the market this year as traders seek a slice of the lucrative AI trade amid a shortage of advanced memory chips.

"Hopes of the market rebounding today after a 10% plunge yesterday faded, triggering panic selling and forcing most stock investors to book losses," said Han Ji-young, an analyst at Kiwoom Securities.

"Doubts are prevalent in the market that the current index level would not be the bottom."

Shares in Taiwan's TSMC, the world's biggest contract chipmaker, fell 3% in Taipei.

South Korean Finance Minister Koo Yun-cheol, speaking at the National Assembly, said the government is reviewing market stabilisation measures, including adjusting regulation related to single-stock leveraged ETFs. Some analysts have said the products exacerbate market volatility.

The share price index has fallen more than 40% since peaking last month. It is nevertheless up 41.5% in U.S. dollar terms year-to-date, making it the best performing major market this year.

"Today's price action suggests that the leverage within Korean equities remains high and a further unwind could be expected," said Asia-Pacific macro strategist Wee Khoon Chong at BNY in Hong Kong.

($1 = 1,451.9000 won)

(Reporting by Gregor Stuart Hunter and Ankur Banerjee; Editing by Christopher Cushing and Subhranshu Sahu)