Maria R. Bastone/AFP/Getty Images
A trader on the New York Stock Exchange shouts orders on Oct. 19, 1987, as stocks were devastated during one of the most frantic days in the exchange's history.
A 10-percent drop in stock prices is generally seen as a "correction" to an inflated market. A plunge of 22 percent over a prolonged period qualifies as a "bear market," typically brought on by anticipation of declining economic activity.
But when the Dow Jones industrial average plunges 22 percent in a single day — as it did 20 years ago today, on Oct. 19, 1987 — the term "blood bath" seems most appropriate.
The Wall Street investment community has another name for it: "Black Monday."
Traders reminiscing Friday herald Black Monday as proof of the stock market's resilience. Soon after, stock prices crawled back and the Dow finished "up" for the year.
But 20 years ago, traders saw it differently.
Signs of the Fall
"I do remember the latter part of the day when it got so bad it got funny," says Larry Wachtel, a veteran stock analyst who was working for Prudential Securities at the time. "And people would come in and say, 'What's happening? We're down 500 points.' And they would turn white."
There were warning signs: in the fall of 1987 the dollar was weak, interest rates were relatively high and stocks had been falling for weeks. The Friday before Black Monday, the Dow fell 100 points. So investors were primed to sell when the market opened on that Monday.
At one point, so many shares were being dumped that the New York Stock Exchange ticker fell behind and TV newscasters couldn't tell how much the market had fallen.
The lagging ticker contributed to the spectacular plunge. Traders were using a new kind of hedging strategy called portfolio insurance, which involved linking stock prices to the futures index. But since no one knew exactly where stocks were trading that day the strategy went awry.
Richard Sylla, who teaches economic history at New York University's Leonard N. Stern School of Business, notes that 600 million shares were traded on Oct. 19, 1987 — a high volume at that time.
"It's estimated by some people that about half of that 600 million — 300 million shares — were people involved in these portfolio insurance strategies," Sylla says. "Their computers were making the decisions for them."
In the years since then, Sylla says, Wall Street has taken steps to prevent another Black Monday.
Is Another Black Monday Possible?
The New York Stock Exchange bars computer-driven trading when prices fall too steeply. And sophisticated new hedging products are meant to protect investors in market downturns.
Wachtel believes the kind of information bottleneck that helped provoke the crash is less likely now.
"There's more savvy on the street," he says. "There's more communication. You can turn on CNBC and immediately you get everything that's happening right then and there. So there is no miscommunication. Everyone is on the same page. So much has changed over the past 20 years that it's hard for me to believe anything like that could happen again."
Other changes were made after the crash. Most notably, the new chairman of the Federal Reserve Board, Alan Greenspan, poured lots of money into the banking system to stabilize the markets.
The Fed has repeated such tactics in subsequent market crises, including this summer's credit crunch spawned by the subprime lending debacle.
"In the short run the central banks do jump in and provide liquidity now more reliably than they did in the past when a crisis comes up," Sylla says.
That has been a mixed blessing, according to some market watchers. The move has made investors more confident in the market as a safe place to invest.
But the precedent may also have led to a belief that the Fed will come to the rescue during bad times. That mindset makes investors less cautious about making risky trades — and that could pose a big threat to the economy down the road.