"Black Monday" and the Long Bull Market

On Monday, October 19, 1987, the value of stocks plum­meted on markets around the world. The Dow Jones Industri­al Average fell 22 percent to close at 1,738.42, the largest one-day decline since 1914, eclipsing even the famous October 1929 market crash.

The Brady Commission (a presidential commission set up to investigate the fall), the SEC, and others blamed various fac­tors for the 1987 debacle — including a negative turn in investor psychology, investors' concerns about the federal government budget deficit and foreign trade deficit, a failure of specialists on the New York Stock Exchange to discharge their duty as buyers of last resort, and "program trading" in which computers are programmed to launch buying or selling of large volumes of stock when certain market triggers occur.

The stock exchange subsequently initiated safeguards. It said it would restrict program trading whenever the Dow Jones Industrial Average rose or fell 50 points in a single day, and it cre­ated a "circuit-breaker" mechanism to halt all trading temporarily any time the DJIA dropped 250 points. Those emergency mech­anisms were later substantially adjusted to reflect the large rise in the DJIA level. In late 1998, one change required program-trading curbs whenever the DJIA rose or fell 2 percent in one day from a certain average recent close; in late 1999, this formula meant that program trading would be halted by a market change of about 210 points. The new rules also set a higher threshold for halting all trading; during the fourth quarter of 1999, that would occur if there was at least a 1,050-point DJIA drop.

Those reforms may have helped restore confidence, but a strong performance by the economy may have been even more important. Unlike its performance in 1929, the Federal Reserve made it clear it would ease credit conditions to ensure that investors could meet their margin calls and could continue oper­ating. Partly as a result, the crash of 1987 was quickly erased as the market surged to new highs. In the early 1990s, the Dow Jones Industrial Average topped 3,000, and in 1999 it topped the 11,000 mark. What's more, the volume of trading rose enor­mously. While trading of 5 million shares was considered a hec­tic day on the New York Stock Exchange in the 1960s, more than a thousand-million shares were exchanged on some days in 1997 and 1998. On the Nasdaq, such share days were routine by 1998.

Much of the increased activity was generated by so-called day traders who would typically buy and sell the same stock several times in one day, hoping to make quick profits on short-term swings. These traders were among the growing legions of persons using the Internet to do their trading. In early 1999, 13 percent of all stock trades by individuals and 25 percent of indi­vidual transactions in securities of all kinds were occurring over the Internet.

With the greater volume came greater volatility. Swings of more than 100 points a day occurred with increasing frequen­cy, and the circuit-breaker mechanism was triggered on October 27, 1997, when the Dow Jones Industrial Average fell 554.26 points. Another big fall — 512.61 points — occurred on August 31, 1998. But by then, the market had climbed so high that the declines amounted to only about 7 percent of the overall value of stocks, and investors stayed in the market, which quickly rebounded.