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TME 031: 1987 Stock Market Crash

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I remember eating with the family as a child. The news was on and they were talking about the stock market. My dad had money in the market so he was listening intently. The year was 1987 the date was October 19 and it was a Monday. It is also known as Black Monday. The crash began in Hong Kong then spread to Europe and then to the United States. The Dow Jones dropped 22.61%. The crash of 1987 was not the worst crash in history but it was a biggest one day percent loss in the history of the Dow Jones Industrial Average.

In 1986 and 1987 the market was booming. The bull market was fueled by low-interest rates, hostile takeovers, leveraged buyouts, and mergers. Many companies were buying each other out. The culture in business at the time was that you could grow quickly if you acquired other companies. Personal computers were becoming a fast growing industry. Everything looked great people were making money. What could go wrong?

Are we asking the right question?

The question of what could go wrong should never be in the mind of a trader. A better question would be when will it go wrong? When will the 1987 market crash happen again? What are some signs? How can we prevent it?

1987 Stock Market Crash: Emotion

The average trader or investor is a bundle of emotion. They see news stories and they feel them in their gut. As traders we need to understand that we can’t answer any of the questions that we asked in the above paragraph. We can however prevent the market crash in our accounts. When we trade systematically we take emotions out of the equation. We trade based on mathematical calculations and not fear and panic. If you look at this chart what do you think the emotional state was?

1987 Stock Market Crash

 

Do you think some might have thought there is no way this thing will ever go down? The last day of the above chart was October 16th 1987. It was one trading day before the 1987 stock market crash. What do you think emotions were like on the next day? Look at the chart below.

1987 Stock Market Crash

 

1987 Stock Market Crash: Perspective

A crash this big catches most everyone off guard. Even a systematic trend following trader’s system will get caught off guard when the market falls this far this fast. The key is to have stops in place. Don’t try to ride the market down to the bottom. When the market crashes the systematic trader gets off the elevator on the way down.

Lets put things into perspective with the trades that our system would have made.

Back Test:

-On August 2 1984 our system gives the signal to buy at $446.

-On October 19 1987 our system hit the trailing stop of $673.

Simple math will show a gain of 51% over that time period. It’s close to three years so divide the 51%/3= 17%. That is a pretty good rate of return. The gain was made long before the market crash. It’s always good to put things into perspective. Even though the market went down by a huge amount if your stops were in place then the trade would have been a gain overall.

 Conclusion

In conclusion markets will fall. It’s the trader’s job to make sure we have the proper stops in place to cut losses out in our own accounts. If the market crashes again like it did in the 1987 market crash, will you be ready. Will you lose more than you should?

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