Black Monday: Stock Market Crash Causes and Impact
What Was Black Monday?
Black Monday was the day, Oct. 19, 1987, when the Dow Jones Industrial Average (DJIA) lost 22.6% of its value in a single trading session. The S&P 500 declined 30% on the same day. Black Monday triggered a global stock market decline. Economists attributed the crash to geopolitical events and computerized program trading that accelerated the selloff. In the aftermath, the Federal Reserve cut interest rates by half a percentage point to encourage more lending and spending. The U.S. Securities and Exchange Commission (SEC) established a number of protective mechanisms, such as trading curbs and circuit breakers, to prevent panic-selling.
Key Takeaways
- Black Monday on Oct. 19, 1987, saw the Dow Jones drop 22.6% in a single day.
- Factors like computerized program trading and portfolio insurance contributed to the crash.
- The 1987 crash led to the introduction of circuit breakers to prevent future market panics.
- Historical Black Monday crashes highlight the unpredictability of markets and the importance of investor preparedness.
- Despite severe downturns, markets often recover, offering potential buying opportunities for investors.
Understanding the Causes Behind Black Monday
The massive stock market drop wasn’t due to a single event, as no major news came out the weekend before the crash.
- A strong bull market overdue for a correction: One of the main factors that drove the Black Monday crash was a strong bull market that was overdue for a major correction in prices since 1982. Stock prices had since then tripled in value.
- Program Trading: Computerized trading, which was still not the dominant force it is today, was increasingly making its presence felt at several Wall Street firms. The stock market crash of 1987 revealed the role of financial and technological innovation in increased market volatility. In automatic trading, also called program trading, human decision-making is taken out of the equation, and buy or sell orders are generated automatically based on the price levels of benchmark indexes or specific stocks. Leading up to the crash, the models in use tended to produce strong positive feedback, generating more buy orders when prices were rising and more sell orders when prices began to fall.
- Portfolio Insurance: Portfolio insurance is a program trading strategy that seems to be one of the key factors at the center of Black Monday. The strategy is aimed to hedge a portfolio of stocks against market risk by short-selling stock index futures, thus limiting the potential losses if stocks decline in price, without having to sell off those stocks. The computer programs began liquidating stocks as certain loss targets were hit, pushing prices lower. This led to a domino effect as the falling markets triggered more stop-loss orders, while bids stopped.
- Triple Witching: October 16, the Friday before the crash, experienced the simultaneous expiration of stock options, stock index futures, and stock index options contracts, a phenomenon known as triple witching. This resulted in extremely high volatility on the last hour of Friday trading, with large sell-offs in the after-hours markets.
- Mass Panic: The international political climate also made investors jittery. The role of media as an amplifying factor for these developments has also come in for criticism. While there are many theories that attempt to explain why the crash occurred, most agree that mass panic caused the crash to escalate. Once the decline started, people continued to sell.
The Aftermath and Response to Black Monday
Following the crash, the Federal Reserve slashed interest rates by half a percentage point, hoping to free up capital and encourage more lending. It also injected billions of dollars into the economy through quantitative easing.
Regulators introduced new protections to prevent flash crashes from program trading. Circuit breakers were introduced in leading stock markets to automatically shut down trading in the event of unusual price movements.
Circuit breakers can stop all trading if an index like the S&P 500 drops unusually. There are also circuit breakers for individual stocks that halt trading in that security only. This is intended to prevent traders from panic selling during momentary drops.
As of 2022, the circuit breakers are set at the levels of 7%, 13%, and 20%. A 7% drop from the close of the previous trading day is considered a Level 1 decline, resulting in a 15-minute trading halt. A 13% decline is Level 2 and also results in a 15-minute halt. A 20% drop ends trading for that day.
Assessing the Risk of Another Crash Like Black Monday
Since Black Monday, a number of protective mechanisms have been built into the market to prevent panic selling, such as trading curbs and circuit breakers. Still, high-frequency trading (HFT) algorithms and supercomputers move huge volumes in milliseconds. These algorithms have been shown to contribute to and cause flash crashes.
The 2010 Flash Crash, caused by HFT, sent markets down nearly 9% in minutes. This led to the installation of tighter price bands, but the stock market has experienced several volatile moments since 2010.
Amid the 2020 global crisis, markets lost similar amounts in the month of March as jobless rates reached their highest levels since the Great Depression, before recovering over the summer of that year.
Key Lessons From Black Monday and Subsequent Market Crashes
Market crashes are temporary. Often, the greatest rallies happen right after a crash. The steep market declines in August 2015 and January and February 2016 were both roughly 10% drops, but the market fully recovered and rallied to new or near new highs in the following months.
Stick With Your Strategy
A solid, long-term investment plan gives investors the confidence to remain calm during market panic. Investors who lack a strategy tend to let their emotions guide their decision-making.
Buying Opportunities
Knowing that market crashes are only temporary, these times should be considered an opportunity to buy stocks or funds. Market crashes are inevitable. Wise investors prepare to buy stocks at lower prices while others sell.
Turn Off the Noise
Over the long term, market crashes such as Black Monday are a small blip in the performance of a well-structured portfolio. Short-term market events are impossible to predict, and they are soon forgotten. Long-term investors are better served by tuning out the noise of the media and the herd and focusing on their long-term objectives.
Exploring Other Notable Black Mondays in History
“Black Monday” often refers to the 1987 crash, but can apply to any sudden Monday price drop.
The first Black Monday was on Oct. 28, 1929, the beginning of the crash that ultimately resulted in the Great Depression. On that day, stocks fell by 12.8%. Black Monday was immediately followed by Black Tuesday on Oct. 29, when stocks fell another 12%. The crash has been attributed to a variety of causes, which historians and economists still debate, including increasing debt and excess use of margin trading, overvalued stocks that lacked the fundamentals to support their prices, errors in the Federal Reserve’s monetary policy, and panic selling.
In August 2015, Chinese stock markets experienced a crash that some termed “China’s Black Monday”. Fears about the Chinese economy then triggered a flash crash in the United States and other countries. On August 24, 2015, the DJIA fell by 1,089 points after the market opened. The drop followed a sharp decline the previous Friday. The market partially rebounded and closed 588 points below the open.
The term is less commonly applied to the crash of March 9, 2020, when the DJIA fell 7.79% due to the uncertainty surrounding the COVID-19 pandemic. Then on Thursday, March 12, the market crashed again by 9.9%. On Monday, March 16, 2020, the market crashed yet again by 12.9% in what some have called Black Monday II.
What Caused Black Monday 1929?
Black Monday often refers to Oct. 28, 1929, when stocks fell by 12.8%. The next day became known as Black Tuesday when stocks dropped by another 12% on Oct. 29, 1929. Previously, on Oct. 24, Black Thursday, stocks had declined by 10% before rebounding within the same day, signaling trouble. Numerous causes for the crash are often cited, and the topic is still debated by historians and economists. Some of the causes often discussed are excessive margin trading, rising debt throughout the economy, a bubble of overpriced stocks without the fundamentals to support their prices, and errors in the Federal Reserve’s monetary policy.
Did People Lose Money on Black Monday?
Yes. Black Monday caused about $500 billion in losses when the Dow Jones Industrial Index fell 508 points. In percentage terms, it is the biggest-ever one-day stock-market loss.
Why Is It called Black Monday?
Black Monday refers not only to the events on Oct. 19, 1987, but also to a number of specific Mondays when sudden, severe, and turbulent events have occurred, from military battles to massacres and stock market crashes. The term seems to have been coined by U.S. Representative John Bell Williams on the floor of Congress in Washington, D.C. on Monday, 17 May 1954. This was the date of the Supreme Court’s decision in Brown v. Board of Education, in which the Court ruled that U.S. state laws establishing racial segregation in public schools were unconstitutional. In opposition to the decision, white citizens’ councils were formally organized throughout the South to preserve segregation and defend segregated schools.
The Bottom Line
Black Monday refers to the catastrophic worldwide stock market crash on Oct. 19, 1987, when the DJIA fell 508 points, or 22.6%, in a single day. It remains the largest one-day decline ever. Other major stock markets saw similarly huge declines.
Stock markets quickly recovered a majority of their Black Monday losses. In just two trading sessions, the DJIA gained back 288 points, or 57%, of the total Black Monday losses. In less than two years, U.S. stock markets had surpassed their pre-crash highs.
After Black Monday, the U.S. Securities and Exchange Commission built a number of protective mechanisms to avoid market panics, such as trading curbs and circuit breakers. In addition, many investors learned the importance of long-term investment strategies and using market crashes as buying opportunities.