Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Black Monday

What it is:

Black Monday, also called "The Crash of 1987," refers to the 509-point fall in the Dow Jones Industrial Average on October 19, 1987. It also refers to October 28, 1929, when the DJIA fell 12.8%.

How it works (Example):

Black Monday is perhaps the most famous trading day in Wall Street history. In one day, the companies of the Dow Jones Industrial Average lost 22% of their value, or about $500 billion.
Put simply, the reason for the market crash was that the supply of stock suddenly far exceeded the demand for stock, and investors, fearing that prices would continue to fall, panicked. However, the specific causes of the market crash are controversial and numerous.  Although many still blame program trading and portfolio insurance for the crash, no one event is solely responsible. Each factor that affected the crash was only part of a larger web of influences. For example:
* The bond market, especially the junk bond market, was popular in 1987, and Treasury yields hit record highs (about 10%). Many investors questioned the wisdom of being in the stock market when they could receive similar or better returns from bonds. Rising crude oil prices also created inflation worries, which further increased bond yields. However, many considered bond yields too high, blaming out-of-control fears about inflation.
* During the crash, a steadily falling market showed that institutional investors' heavy dependence on program trading and portfolio insurance actually did more harm than good.  In a rapidly declining market, the desire to sell only exacerbated the downward pressure on the averages. Further, the institutional investors' program trading mechanisms hastened the downward spiral by automatically placing stop-loss orders after the market crossed certain thresholds. On Black Monday, the heavy sell volume overwhelmed the NYSE's automated order system, and many traders simply gave up trying to execute trades for a time. These events created serious information gaps and delays, which further inflamed the panic selling.
* The United States trade deficit was relatively high, and the House of Representatives passed an amendment aimed at reducing the trade surpluses of many Asian countries, which made Wall Street worry that there would be less Asian demand for U.S. Treasuries. Wall Street also worried about the weakening dollar.
* Events in the Middle East were creating concerns about military action or war. A few days before the crash, Iranian missiles hit a U.S. tanker near Kuwait, five months after an Iraqi missile hit a U.S. frigate. This drove the Dow Jones Industrial Average down on October 16. On October 19, Black Monday, two U.S. warships shelled an Iranian oil factory.
* A series of corruption and insider trading investigations continued to get headlines in 1987. Most major investment banks came under SEC scrutiny, including Drexel Burnham Lambert, Goldman Sachs, Merrill Lynch, Paine Webber, and  Peabody. Some of the Wall Street's most famous names were also caught in a variety of legal troubles, including Ivan Boesky, Michael Milken, and Carl Icahn. As a result, many investment banks struggled with major layoffs, disenchanted clients, and bitter investors.

Why it Matters:

Black Monday was the biggest one-day loss in the history of the Dow Jones Industrial Average and was a reminder of the power of the markets. It became an example of the power of the lack of investor confidence and the interrelation of global financial markets and economic factors. It also exposed the weaknesses of new portfolio strategies (namely portfolio insurance and program trading) and created opportunities for new technologies (namely circuit breakers and increased trading capacity) that help prevent or mitigate selling panic. For individual investors, Black Monday became a prime example of the risks of short-term investing and of the temporary nature of trends.