Black Monday (1987)

Overview

On Monday, October 19, 1987, stock markets around the world crashed. The crash began in Hong Kong, spread west to Europe, and hit the United States with devastating force. * The Drop: The Dow Jones Industrial Average (DJIA) plummeted 22.6% (508 points) in a single trading session. This remains the largest one-day percentage decline in history.

The Culprit: Program Trading

While there were macroeconomic concerns (trade deficit, weak dollar), the severity of the crash is largely attributed to "Portfolio Insurance." * The Mechanism: This was a computerized hedging strategy designed to limit losses by automatically selling index futures when prices dropped. * The Vicious Cycle: As prices began to slip, these programs triggered massive sell orders. The selling drove prices down further, which triggered even more sell orders. This feedback loop caused a liquidity crisis where buyers simply evaporated.

The Aftermath & Legacy

The crash led to significant reforms in market structure and regulation. * Circuit Breakers: Exchanges implemented mechanisms to temporarily halt trading during extreme volatility to prevent panic selling. * The Fed's Role: Federal Reserve Chairman Alan Greenspan famously affirmed the Fed's readiness to serve as a source of liquidity to support the economic and financial system.

Key Takeaway

• Systemic Risk: It highlighted how financial innovation (like automated hedging) can create new, unforeseen systemic risks.
• Resilience: Unlike 1929, this crash did not lead to a Great Depression. The economy decoupled from the stock market and continued to grow, proving that the stock market is not the economy.