1. Historical Context
During the first months of 1987, the American stock markets were experiencing an extraordinary bull market. However, the US trade balance worsened and the value of the dollar fell against other international currencies.
2. The Breakdown Event
On October 19, 1987, known as 'Black Monday', the New York Stock Exchange opened with massive selling pressure. Unlike in 1929, the decline was exacerbated by early computer-automated 'portfolio insurance' systems, which automatically sold future contracts if stocks fell. These primitive algorithms entered a closed sales feedback loop. The Dow Jones index plummeted to a historic 22. 61% in a single daily trading session, doubling the fall on Black Tuesday in 1929.
3. Global Economic Impact
Panic immediately spread to the stock markets in London, Tokyo and the rest of the world. To avoid a banking system freeze, the Federal Reserve declared its willingness to act as an emergency liquidity provider for Wall Street. The market managed to recover from the crash in the following two years without triggering a major economic recession.
Key Financial Lesson (Psychology of Money)
Automated trading technologies individually designed to protect an investor from market losses can trigger a widespread systemic collapse by trying to sell all at once during times of stress.
4. Practical Case or Real Life Example
This event inspired the development of trading circuit breakers on Wall Street that pause market operations if indices fall more than 7%, 13% or 20% to slow feedback to algorithms.