Portfolio Insurance and Technical Analysis Before the October 1987 Black Monday Stock Market Crash
After the stock market crash on October 19, 1987, both individual and institutional investors were asked about their “Investor Psychology” on “Black Monday” and what triggers kept them in or out of the market that day.
1. No news story or rumor appearing on October 19th or over the preceding weekend was responsible for investor behavior.
2. Investors’ importance rating of news appearing over the preceding week showed only a slight relation to decisions to buy or sell.
3. There was a great deal of investor talk and anxiety around October 19 due to valuation — much more than suggested by the volume of trade.
4. Many investors thought that they could predict the market through technical analysis.
5. Both buyers and sellers generally thought before the crash that the market was overvalued due to technical factors.
6. Most investors interpreted the crash as due to the psychology of other investors.
7. Many investors were influenced by technical analysis considerations.
8. Portfolio insurance was only a small part of predetermined stop-loss behavior.
9. Some investors changed their investment strategy before the crash because of valuation.
Reviewing the “Technical Analysis” — the moving average orientation throughout most of 1987 was in the “Most Bullish Orientation” possible as price continued to ‘bounce’ off the 20 and 50 EMAs.
However, this structure changed in September. Price formed a slight negative momentum divergence going into the 1987 price high in late August. Price then retraced, breaking EMA support just as it had in April & May, which only serves as a warning rather than an official “Trend Change” signal.
Was it forecast by technical analysis? No but at a minimum, technical analysis warned of greater downside odds than upside odds, though again it’s easier to anticipate the possible direction of a move rather than the magnitude of the move.