stock market crashes

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    Inexperienced investors could be forgiven for thinking a stock market crash is a common occurrence. Most people remember 1987. They remember stocks falling heavily and being the top news, stockbrokers jumping out of windows and people losing everything in a margin call. It’s funny how those negatives stick in people’s minds, and sadly still breed fear today.

    “The 1987 crash "marked the end of a five-year 'bull' market that had seen the Dow rise from 776 points in August 1982 to a high of 2,722.42 points in August 1987." Unlike what happened in 1929, however, the market rallied immediately after the crash, posting a record one-day gain of 102.27 the very next day and 186.64 points on Thursday October 22. It took only two years for the Dow to recover completely; by September of 1989, the market had regained all of the value it had lost in the '87 crash.” -

    What is often forgotten about that year, is that markets were incredibly strong most of the year, and even after the crash, they were higher than at the beginning of the year. 1987 was not a crash, it was merely a correction. A crash is when the bubble bursts, and everyone’s wealth implodes before their eyes. Secondly, after the crash, markets climbed higher again. The only people who lost money in the crash were those who bought in August and sold at the end of October. Everyone else made money or broke even. As in any mania, greed was rife. People had been watching markets rise for so long they thought it would never end. Some borrowed heavily to invest, and came unstuck in mid October.

    So what caused the correction? Contrary to popular belief it did not happy simply because stocks were overpriced. If they were overpriced, why did they go back up after the crash? They weren’t cheap, that’s for sure. The market had simply gotten ahead of itself. In mid 1987 the economy was running out of control, interest rates were sky high and inflation was rampant. The Federal Reserve tried to slow things by increasing interest rates by 50 basis points in one hit. That was supposed to shock people back to reality, instead it had little effect. A 50 basis point rise was unheard of at that time. There was so much momentum built up, one scary rate rise was not going to do the job. Six weeks later, the Federal Reserve boosted rates another 50 basis points. This time the market started to take notice.

    One major factor in the crash was European investors who owned U.S stocks. The U.S dollar was strong at the time, and U.S exporters were crying out for help. The foreign debt was spiraling out of control, and the Government finally took action. On the 14th October 1987, Treasury Secretary James Baker announced:

    “The strong dollar policy is damaging our export industry, and we must be prepared to let the dollar slide.”

    Now if you were a European investor with stocks or bonds in U.S currency, that statement is the worst possible news you could hear. A falling U.S dollar meant that your assets fell in value in your currency terms. Even if the stocks and bonds themselves went up or stayed flat, you lost money. This was the final straw. European investors sold U.S stocks in droves. They were the lucky ones because they got out first. It should have been obvious to most Americans what was going to happen, but few considered the view from Europe. From here the markets gained downside momentum, like an avalanche. On Friday the 16th October, the Dow fell more than 5%.

    This massive fall made the front page of the weekend papers, and people became very scared all of a sudden. Many vowed to sell all their stocks first thing Monday morning, before things got any worse. For the last week, Europeans and smart Americans had been doing nothing but selling. Nobody was placing buy orders. When the market opened on Monday 19th October, people were jumping over each other to sell but there was nobody who wanted to buy. Prices went into free-fall, as desperate punters sold at any price. Genuine sellers accounted for around 10% of the fall that day. Unfortunately, brokers had just begun using computers to automate trading. These computers had stop loss orders programmed in, so that they would automatically sell when prices went too low. The genuine sellers started to trigger these stop-loss levels, and the computers started selling on masse. Like a chain reaction, more and more computers did more and more selling, until the plugs were finally pulled. Buyers by this stage had smelt an opportunity, and happily started buying into the ever-increasing panic. Eventually prices stabilised. By then the Dow had fallen 22.4%.

    Many changes have been made since then, and many lessons learned. Clearly some of the comments made by prominent economists could have been toned down. Computers with stop-loss triggers have been modified to ensure the cascade effect does not happen again. What’s more, ‘curbs’ and ‘circuit breakers’ have been introduced into the NYSE. So much for free markets. Nowadays, when the market falls a certain amount, brokers are forced to buy into the fall. This creates the effect of steering markets where you want to go. A ‘circuit breaker’ is triggered when the market falls very heavily. The stock exchange simply halts all trading, to give investors a chance to calm down.

    As well as these measures, the Federal Reserve has established a department called the “Plunge Protection Team” or PPT. This department’s job is to ensure the stability of the financial markets by buying large amounts of stock when markets are falling. Their actions are now becoming well known, and often they will issue a report stating how much money they are injecting into the market or taking from it. For many years it was believed the department was an urban legend, but recently certain politicians and economists have admitted its existence.

    Another factor that suggests a crash can never happen again, is the information age. Millions of people on the Internet now trade stocks with exactly the same information their brokers have. Furthermore public participation in the markets is at a record and will only increase. The markets should have crashed in March 2000. They should have crashed again in Sept 2001. But they did not. Technology has improved. There have been policy changes. More and more investors know that any dip is a buying opportunity.

    If you do not believe any of this, take a look at the Dow chart just after September 11. If the largest terrorist attack in U.S history could not cause the market to crash, what could? Someone was buying up the markets at that time, and buying so big that the markets actually went higher than they were before the attack. It stinks, because America is supposed to be the beacon of freedom, yet they have the most corrupt and manipulated financial markets in the world. We can whine all day about it, or we can accept it and use this knowledge to our advantage. There will never be another crash like 1987. Markets may fall over time, but a 22% fall in one day is pure history.

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