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Posted on 10 April 2011 | 5,697 views

The Causes of the Stock Market Crash of 1987

Known as “Black Monday,” the Dow Jones Industrial Average plummeted 508 points, losing 22.6% of its total value on October 19, 1987. It was almost twice as bad as the stock market crash of October 29, 1929 because on that day the DJIA fell an approximated 11.7% and started the Great Depression.

Some believe the market crash was caused by an irrational behavior on the part of investors. Some analysts believe that excessive stock prices and computerized trading were the cause.

In searching for the cause of the 1987 crash, many analysts blame the use of computer trading (also known as program trading) by large institutional investing companies. Many common stocks in the New York Stock Exchange were not traded until late in the morning of October 19 because the specialists could not find enough buyers to purchase the amount of stocks that sellers wanted to get rid of at certain prices. As a result, trading was terminated in many listed stocks. This insufficient liquidity may have had a significant effect on the size of the price drop, since investors had overestimated the amount of liquidity.

Two economists from the Securities and Exchange Commission, Mark Mitchell and Jeffry Netter, published a study in 1989 concluding that the anti-takeover legislation did trigger the crash. They note that as the legislation began to move through Congress, the market reacted almost instantaneously to news of its progress. Between Tuesday, October 13, when the legislation was first introduced, and Friday, October 16, when the market closed for the weekend, stock prices fell more than 10 percent — the largest 3-day drop in almost 50 years.

On Monday, the Dow dropped about 200 points or 9% in the first hour and half. During the day, most institutional investors implemented various computer-based portfolio insurance programs. Buyers waited, knowing the more the market dropped, the more selling would have to take place. By the end of the day, the Dow had lost 508 points.

Investors who sold, were taken to the cleaners and those who held and continued a disciplined and systemic approach received rewards. In fact, by the end of 1987, total return for the year, including dividends, approximated 5%.

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