What is Black Monday?
Performance of the Dow Jones Industrial Average around the time of Black Monday.
Black Monday is remembered as the beginning of a global stock market decline. To date, it’s one of the most infamous days in the history of stock markets.
The term “Black Monday” typically refers to the crash in 1987. But, it’s also used to refer to other severe market crashes.
What causes market crashes?
The first was the introduction of computerized trading systems. Today, most trading activity is facilitated by computers, but this wasn’t always the case. Before the 1980s, stock markets were typically noisy and crowded venues where traders exchanged assets directly on the trading floor of the exchange.
The trading floor of the New York Stock Exchange (NYSE) in 1963, before the introduction of computerized trading systems. Source: Library of Congress. Image modified from original.
Throughout the 1980s, however, trading activity started to rely more heavily on computer software. The shift to computerized trading enabled considerably faster trading activity with systems capable of placing thousands of orders in seconds. Naturally, these advancements also affected the velocity of large price moves. In contrast, today’s trading bots can move trillions of dollars of value within seconds of an unexpected news event.
Other factors, such as a trade deficit in the United States, international tensions, and other geopolitical circumstances have also been named as causes. On top of that, the growing reach of the media certainly amplified the effects and severity of the event.
What is a circuit breaker?
If the S&P 500 moves down more than 7% within a trading day, trading is halted for 15 minutes, then restarted. This is called a Level 1 circuit breaker. If the market drops further and reaches 13% from the daily open, it’s halted again. This is called a Level 2 circuit breaker. Then, after a 15-minute break, trading is restarted. If the price reaches a 20% loss from the market open, trading is halted for the rest of the day. This is called a Level 3 circuit breaker.
Advantages and disadvantages of circuit breakers
While circuit breakers may be effective at preventing flash crashes, they have been a topic of controversy.
Decreased liquidity can lead to more volatility, as there may not be enough orders to absorb an unexpected spike in supply. Critics argue that without the influence of circuit breakers on areas of liquidity, the markets are more likely to reach a natural equilibrium.
When it comes to global market indexes like the S&P 500, circuit breakers are only triggered on moves to the downside. On the other hand, they can be activated on individual securities on moves to the upside as well.
How to prepare for market crashes
Consider creating an investment plan or an overall trading strategy. When the market crashes and many investors are panic selling, it’s important to remain calm, rational, and avoid emotional decision-making. Creating a long-term investment plan or trading strategy is essential for that, as it shouldn’t allow you to make impulsive decisions.
As for global market crashes, they all have been temporary so far. While times of economic recession may span multiple years, the markets tend to recover afterward. If you zoom out far enough, the global economy has been in consistent growth for centuries, and these corrections are only temporary setbacks.
Performance of the Dow Jones Industrial Average between 1915 and 2020.
Other notable Black Mondays
October 28th, 1929
Stock markets crash, preceding the Great Depression in the 1930s. Considering its long-term economic effects, the crash during the autumn of 1929 has been the most destructive stock market crash to date.
September 29th, 2008
March 9th, 2020
Worst day for the US stock market since the Great Recession, fueled by the coronavirus pandemic and an oil price war. At the time, it had been the largest single-day drop since 2008. But, as you’ll see in the next paragraph, this record only held for a single week.
March 16th, 2020
Summing up, Black Monday was a severe market crash in 1987. As mentioned, the term may also be used to refer to other stock market crashes, such as the ones of 1929, 2008, and 2020.
Following the events of Black Monday, new regulations were implemented to try to mitigate the effects of stock market flash crashes. One of the most impactful and controversial of these regulations is the circuit breaker, which halts trading when predefined percentage loss levels are hit.