What was the Stock Market Crash Of 1987?
The stock market crash of 1987 was a rapid and severe downturn in stock prices that occurred over several days in late October 1987, affecting stock markets around the globe. In the run-up to the 1987 crash, the Dow Jones Industrial Average (DJIA) more than tripled in the prior 5 years. The Dow then plunged 22% on Black Monday - October 22, 1987. The Federal Reserve and the stock exchanges subsequently intervened to limit the damage by invoking so-called circuit breakers to slow down future plunges.
Explaining the Stock Market Crash Of 1987
After five days of intensifying stock market declines, selling pressure hit a peak on October 19, known as Black Monday. The Dow Jones Industrial Average (DJIA) fell a record 22% on that day alone, with many stocks halted during the day as order imbalances prevented true price discovery. Thanks to support from the Fed and exchange lockouts, the selloff halted the next day and the market recovered most of its losses rather quickly. While speculation remains as to the exact causes of the crash, many people point to the lack of trading curbs, which markets have today, and automatic trading programs in place at the time as possible culprits.
The lead-up to October 1987 saw the DJIA more than triple in five years. As a result, valuations rose to excessive levels, with the overall market's price to earnings ratio climbing above 20, implying very bullish sentiment. And while the crash began as a U.S. phenomenon, it quickly affected stock markets around the globe; 19 of the 20 largest markets in the world saw stock market declines of 20% or more.
Program Trading and the 1987 Crash
Investors and regulators learned a lot from the 1987 crash, specifically with regards to the dangers of automatic or program trading. In these types of programs, human decision-making is taken out of the equation, and buy or sell orders are generated automatically based on the price levels of benchmark indexes or specific stocks. After the crash, exchanges implemented circuit breaker rules and other precautions to slow down the impact of trading irregularities in hopes that markets will have more time to correct similar problems in the future.
While the 1987 crash had program trading as a key cause, the vast majority of trades back then were executed through a slow process, glacial by today's standards, that often required multiple telephone calls and interactions between humans. Today, with the increased computerization of the markets, including the advent of high-frequency trading (HFT), trades often are processed within milliseconds. With incredibly rapid feedback loops among the algorithms, the selling pressure can build into a tidal wave within moments, wiping out fortunes in the process.