stock market crash and the possible causes

stock market crash and the possible causes

Introduction

The stock market crash which is also known as Black Monday is a stock exchange phenomenal that took place on October 19, 1987, where stockbrokers in major cities such as Berlin, London, New York and other cities of the world with exchanges, were hit by a financial strut that resulted into the tripping down of stock market prices across the globe (Shiller, 2012). The fall was brought by several issues ranging from program trading, deficits in trade and budgets, overvaluation and illiquidity, among other factors. The Dow Jones Industrial Average which is an index that keeps track of 30 blue-chip companies with stable earnings in the United States of America suffered a fall of 22.6% making it the largest percentage drop in the history. This paper will analyze the stock market crash and the possible causes.

Causes of the Crash

            Computer trading or program trading which involves the usage of algorithms generated by the computer to trade in large stock volumes and with high frequency was seen as a significant cause for the crash as the idea was still new and had not been tested nor adopted by majority of stockbrokers at the stock exchange markets (WALDROP, 2012). The computers were programmed in a manner to order stock trades automatically with specific prevailing market trends that were deemed favourable, which made program trading dissolve stocks as hits were observed. Target suffered significant loss hence pushing the prices lower to the shock of the exchanges (WALDROP, 2012). This led to a chain of events as the exchange markets fell further triggering more stop-loss orders being issued to help save further decline.  

The process of selling orders during the crash was complicated as the mechanisms used financial market were unable to deal with the massive flow and as such, common stocks were traded in the morning of October 19 since there were no enough buyers to purchase the shares at the New York Stock Exchange that the sellers were willing to dispose at specific prices (Amihud et al. 2011). This led to stocks trading termination of the listed stocks creating a situation of insufficient liquidity which hurt the price size drop since the potential investors had overestimated the amount of liquidity.

People used to buy actual shares of stock through the stock market and index option while in the future market options, people were only purchasing the rights to buy or sell stocks at specific prices. The interplay between these derivatives contributed mostly to the crash since its value comes from the changes of stock exchange prices as no actual shares were owned (Amihud et al. 2011). This was considered the primary cause of the crash as per The Brady commission findings which were formed to look into the matter.

Conclusion

The stock market crash of October 19, 1987, was felt in major cities with stock exchanges across the globe, causing a considerable amount of loss in the stock exchange market. The crash was brought about by several issues which if proper measures were in place could have helped in avoiding the occurrence of the crash. Though the crash was short-lived, the loss suffered on that particular day was enormous, and this led to the formation of The Brady commission which made significant findings and concluded that the failure of derivative market and stock markets to agree on their mode of operation was the primary cause of the crash.

References

Amihud, Y., Mendelson, H., & Wood, R. A. (2011). Liquidity and the 1987 stock market crash. The Journal of Portfolio Management, 16(3), 65-69. doi:10.3905/jpm.1990.409268

Shiller, R. (2012). Investor Behavior in the October 1987 Stock Market Crash: Survey Evidence. doi:10.3386/w2446

WALDROP, M. M. (2012). Computers Amplify Black Monday: The sudden stock market decline raised questions about the role of computers; they may not have actually caused the crash, but may well have amplified it. Science, 238(4827), 602-604. doi:10.1126/science.238.4827.602