Black Monday: Definition in Stocks, What Caused It, and Losses

What Was Black Monday?

Black Monday occurred on Oct. 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. The event marked the beginning of a global stock market decline, and Black Monday became one of the most notorious days in financial history. By the end of the month, most of the major exchanges had dropped more than 20%.

Economists have attributed the crash to a combination of geopolitical events and the advent of computerized program trading that accelerated the selloff.

Causes of Black Monday

The cause of the massive stock market drop cannot be attributed to any single news event since no major news event was released the weekend preceding the crash. However, several events coalesced to create an atmosphere of panic among investors.

• 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: The trade deficit of the United States widened with respect to other countries. 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: Oct. 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: Crises, such as a standoff between Kuwait and Iran, which threatened to disrupt oil supplies, 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.

Aftermath of 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 protective mechanisms to prevent flash crashes due to program trading. Circuit breakers were introduced to leading stock markets to automatically shut down trading in the event of unusual price movements.

Circuit breakers can halt all trading on an exchange if a certain index (in the U.S., the S&P 500) experiences an unusual drop. There are also circuit breakers for individual stocks, halting 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.

Can It Happen Again?

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. However, high-frequency trading (HFT) algorithms driven by supercomputers move massive volumes in just milliseconds, which increases volatility.

The 2010 Flash Crash was the result of HFT gone awry, sending the stock market down 10% in a matter of 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.

Lessons From Black Monday and Other Market Crashes

A market crash of any duration is temporary. Many of the steepest market rallies have occurred immediately following a sudden crash. The steep market declines in August 2015 and January 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 well-conceived, long-term investment strategy based on personal investment objectives should provide the confidence for investors to remain steadfast while everyone else is panicking. 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. Savvy investors have a shopping list prepared for stocks or funds that would be more attractive at lower prices and buy while others are selling.

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.

Other Black Mondays

While the term "Black Monday" is most commonly applied to the stock market crash of 1987, it can also be applied to any other sudden, one-day drop in prices on the first day of the week.

The first Black Monday was on Oct. 28, 1929, just after the beginning of the crash that ultimately resulted in the Great Depression. On that day, stocks fell by 12.8%. The crash was attributed to low wages, increasing debt, and an excess of large bank loans that could not be liquidated.

The term can also describe the flash crash on August 24, 2015, when the DJIA fell by 1,089 points just after the market opened. The drop, which followed another sharp decline the previous Friday, was attributed to economic worries about China. The market partially rebounded and closed 533 points below the open.

The term is less commonly applied to the crash of March 9, 2020, when the DJIA fell nearly 8%. due to the uncertainty surrounding the COVID-19 pandemic. The following Thursday, the market crashed again by 10%.

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, US stock markets had surpassed their pre-crash highs.

Since then, the U.S. Securities and Exchange Commission has built a number of protective mechanisms to avoid market panics, such as trading curbs and circuit breakers.