What it means
Before the crash, share prices had risen strongly for several years, and valuations looked stretched to many observers. On Monday 19 October 1987 selling overwhelmed the market, and prices fell at a speed that exchanges and brokers struggled to handle.
Telephones and computer systems were swamped, and many orders could not be executed at the prices investors saw on screen. Several causes are usually cited.
Computer-driven strategies known as portfolio insurance automatically sold index futures (contracts on the level of a share index) as prices fell, which added to the selling pressure. Investor nervousness about rising interest rates and a weak dollar also played a part, and the exact weight of each factor is still debated.
The economic damage was far smaller than in 1929. The central bank, the Federal Reserve, publicly stated that it was ready to provide liquidity, meaning cash, to the financial system, and this calmed fears of bank failures.
Markets recovered much of the loss within a couple of years. Changes followed.
Exchanges introduced circuit breakers, which pause trading when prices fall by set amounts, to give people time to take stock. Settlement systems, communication between exchanges and systems for handling heavy volume were also improved.
For business readers, the main lessons concern liquidity and automated trading. Markets can become one-way very quickly when many participants follow the same rules, and a plan that works for one investor can fail when everyone uses it at once.
It also changed how people talk about risk. Before 1987 many managers assumed that a hedging rule would always find a buyer at a sensible price, whereas afterwards stress tests began to ask what happens when no one wants to trade.
That question is now standard in risk reports for banks, funds and corporate treasuries.
In practice
Real-world examples.
Example
A risk manager at a pension fund runs a stress test that assumes a one-day fall of 20% in share prices. The test shows how much cash the fund would need to meet payments without selling at the bottom. The scenario is directly inspired by the 1987 event.
Example
An exchange operator explains to a regulator how its circuit breaker works. If a major index falls by a set percentage in one day, trading pauses for a fixed period. The aim is to slow panic selling and give investors time to assess information.
Example
A corporate treasurer, whose company holds a $5,000,000 share portfolio as part of its cash management, decides to cap that holding at a small proportion of total liquid assets. The reason is that markets can fall fast and cash may be needed at once. She also keeps a committed bank facility as a backstop.
Formula
Calculation
Percentage fall = points lost / opening level
On 19 October 1987, the Dow fell by about 508 points from a prior close of about 2,247. Percentage fall = 508 / 2,247 = 22.6%. The closing level was therefore about 2,247 - 508 = 1,739. A portfolio of $1,000,000 that moved in line with the index would have dropped by about $226,000 in that single day.Case study
Seen in the real world.
Greystone Asset Managers is an illustrative, fictional firm that in the mid-1980s sold clients a strategy designed to cut losses automatically by selling index futures as prices fell. The approach worked well in small declines and attracted a large amount of money.
On a day of sharp falls, the strategy generated a large wave of sell orders, but buyers had disappeared, and the firm sold at much lower prices than its models assumed. The illustrative result was a loss far bigger than the protection it had promised.
After the event, the firm's fictional chief executive added limits on the size of the strategy, tested it against days with no buyers and told clients plainly that automatic protection can fail when everyone sells together. The lesson is that models rely on market liquidity, which is not guaranteed.
Watch out
Common mistakes.
- Assuming that every crash leads to a depression, when the 1987 fall was followed by recovery and no major economic downturn.
- Blaming computers alone, when high valuations, interest rate worries and investor behaviour all contributed.
- Treating the largest one-day fall as the whole story, when the damage came from a shortage of buyers and the speed at which prices moved.
Questions
People also ask.
What was Black Monday?
It was Monday 19 October 1987, when the Dow Jones Industrial Average fell by more than 22% in a single session, followed by sharp falls in markets worldwide.
What are circuit breakers?
They are rules that temporarily halt trading when an index falls by a set percentage, designed to calm markets and allow information to be absorbed.
Did the market recover?
Yes, markets regained much of the loss over the following two years, and the broader economy continued to grow.
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