By Dheeraj Veludandi. Edited by Arjun Chandrasekar.
Overview
Black Monday occurred on October 19, 1987, where financial markets all over the world crashed immensely, with the U.S stock market specifically falling more than 20% on that day. It was the biggest percentage decline in the history of the U.S stock market shown by how the Dow Jones Industrial Average dropped more than 22% on Black Monday and the S&P 500 dropped more than 20.4%. To get a clearer perception on how impactful Black Monday was, the worst one day drop for Dow was in 1929 which was about 12%. This decline is just half of the decline that happened on Black Monday.
What Caused it to Happen?
Market analysts believe that the main reason for this crash is due to a strong bull market. 1987 was the fifth year of a major bull market and stock prices tripled in value four a half years before Black Monday.
Another reason for this crash is computerized trading or program trading. This was new to the markets in the 1980s because technology as a whole wasn’t nearly as advanced. Computerized trading allowed brokers to place large orders in a short amount of time. Software programs were developed by banks which were programmed to execute stop loss orders. Therefore, on Black Monday, the computerized trading system caused a domino effect since there were more sellings as the market dropped which caused it to drop even more. The initial selling as the prices dropped caused computerized trading systems to sell even more. These new programs weren’t capable of dealing with flaws and switchbacks, and ironically made the problem worse.
The third reason for this crash was “portfolio insurance.” Portfolio insurance was where institutional investors took short positions in the S&P 500 futures the the portfolio insurance were designed to increase short future positions in case of a decline in stock prices. So, there was a dominio effect on this as well as computerized trading programs. When the stock prices dropped from the crash, investors sold S&P 500 futures contracts. The pressure on the futures markets caused there to be more pressure on the current market.
A Unique Market Crash
The world has not seen a market crash like the 1987 one ever before. This crash was way different from the crash of 1929 or the 2008 one because it was way shorter and the recovery time was quicker for Dow since it managed to recover 288 points of the 508 points it had lost in just a couple days after Black Monday. By September of 1989, the stock market made back its losses, and after a decade, Dow managed to rise above the 10,000 mark.
The Aftermath
The outcome of the Black Monday crash of 1987 was the development of circuit breakers. A circuit breaker is a market mechanism that halts trading in individual securities for a certain period when a stock declines by a specific percentage. For example, in 2019, if the S&P 500 falls more than 7% compared to the previous day’s closing price, it trips a circuit breaker which causes all stock trading to stop for 15 minutes. A second circuit breaker is triggered if the stock drops below 13% from the previous closing price and third circuit breaker if 20%. The reason circuit breakers were established was to avoid a market crash due to panic from investors selling out what they hold. People say that the Black Monday Crash of 1987 was caused by pure panic and circuit breakers are designed so investors can make wiser trading decisions and not blindly sell.
