It would have been more than appropriate if a few veteran traders looked over their shoulders on Friday in the midst of a modest stock market correction. After all, it was the 25-year anniversary of one of the biggest stock market crashes in history.
On Oct. 19, 1987, the major stock market index suffered a selloff unlike anything that had ever been seen or seen since then as the Dow Jones Industrial Average fell 508 points. While there have been bigger point declines — 777 points on Sept. 29, 2008, and 685 points on Sept. 17, 2001, the first day of trading following the terrorist attacks on the World Trade Center — no other day has seen a bigger percentage decline.
On Oct. 19, 1987, the Dow was down 22.6 percent. A similar decline today would see the blue chip index fall about 3,500 points.
What led to the crash of 1987?
“Trouble in the markets had been brewing for months," said Paul Heller, the head of the Vanguard Retail Investor Group. "The bond market underwent a slow meltdown in the spring and summer of 1987. On Friday, Oct. 16, the Dow fell 108 points, or nearly 5 percent.”
The stage was set, he said, for a dark Monday.
“After a weekend of worrying, investors began selling when the markets opened, triggering a free fall in stock prices that continued through the next morning," Heller said. "Then stocks reversed course, and the Dow made record gains on Tuesday and again on Thursday.”
When the smoke cleared on Oct. 19, 1987, the Dow industrials closed at 1,738. As Heller suggested, the market rebounded the next day and gained 186 points, a gain of 10.1 percent.
In a speech to the Securities Industry Association two months after the crash, then-chairman of the Securities and Exchange Commission, David Ruder, said the crash was a true test of the financial system.
“Most importantly, all of the major U.S. broker-dealers remained in sound financial condition throughout the market break, a credit to their strong capital positions and successful risk management," Ruder said. "Moreover, despite a tidal wave of volume, trades remained under control. And, thanks to the extraordinary back-office efforts of the securities industry, clearance and settlement systems functioned relatively well.”
The SEC embarked on a series of changes following the record one-day decline to prevent similar crashes in the future. So-called “circuit breakers” were established to slow down and potentially halt trading if prices were to spiral lower again. Yet, in reality, the stock market has successfully avoided a reoccurrence of 1987 even as volume has swelled.
To be sure, if a similar correction were to occur, it would rattle investors, perhaps driving many away from the stock market forever. Yet learning lessons from Oct. 19, 1987, could pay off in the future.
Tom Stevenson, investment director at Fidelity Worldwide Investment, said the key is to remain calm and carry on.
“By the time you have recovered your equilibrium, the moment to sell has very likely passed, and by panicking at this stage you will simply miss out on the subsequent recovery,” Stevenson said.
He also points out the importance of having a long-term view toward investing. In a strange way, the crash of 1987 seems almost small when compared to the current level of the Dow industrials above 13,500.
Simple steps — like not trying to time the markets, investing regularly and reinvesting dividends — can prove to be rewarding.
“When your emotions are running high you will make the wrong investment decisions because our brains are hardwired to run from danger," Stevenson said. "The best investors do the reverse. They walk toward danger, albeit with their eyes wide open.”
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