The Next Stock Market Crash Will be Bigger Than the 1987 Stock Market Crash
Prepare yourself for another stock market crash as big as the free fall in October 1987. If it happened today, the Dow would drop 2,965 points on the session to finish at roughly 10,158. We’re kidding ourselves if we think that market regulatory reforms such as Circuit Breakers will be able to prevent it.
In absolute or percentage terms, the 1987 Stock Market Crash was one of the largest one-day drops ever — beating the 13.6% drop on the worst day of the 1929 crash but The Largest Ever One-Day Percentage Drop in the Dow Jones Industrial Average Occurred on December 12, 1914 — falling 24.39 percent and beating the 1987 crash drop of 22.61 percent.
But then again, the 1914 and 1929 crash was caused only by human beings. The 1987 Crash, on the other hand, was largely computer-driven.
The 1987 crash was mostly caused by a primitive computerized trading strategy called “portfolio insurance” — the idea behind this was that investors could not lose too much money if they sold futures every time the market dipped, so that further dips would be matched on the short futures position.
Today, computers move around large orders, front-running them and making it more difficult to trade in large size than it was 15 years ago. More dangerous, these high-frequency traders are able to place orders that disappear when they are hit, thus depriving the market of liquidity altogether.
That’s how in the “2010 Flash Crash” a couple of years ago stocks traded for $0.01 and $99,999. In 1987, machines pushed the frontier of crash size from 13.6% to 22.6%. This time, they are much more capable — and could push the size of the crash frontier much, much further.
A single-session drop of at least 20%, for example, is predicted over long periods to occur once every 104 years, on average, but it could happen at any time. That’s why you always have to prepare for it, because you don’t know when it will occur.
Stock Market Crashes are an inevitable feature of the investment arena because every market, to a more or less similar degree, is dominated by its largest investors. When those large investors collectively want to get out of stocks, which will happen on occasion, they will find ways to circumvent myriad downside protections such as circuit breakers that may be in place.
Do you expect another crash like 1987’s?