The Huge Difference Between The "Flash Crash" And The Crash Of '87

black monday

What’s amazing is that in most of the discussions about the “Flash Crash” from two Thursday ago, there’s been very little talk about the parallels between it and the famous Black Monday crash of 1987.

But the similarities are meaningful and important.

As Craig Pirrong points out, the kind of large bets that traders made leading up to the crash (whether at Universa or Waddel) aren’t that different from the “portfolio insurance” schemes that arguably caused the Black Monday crash.

In both cases, more or less, you saw a feedback loop of declining prices prompting more and more of the same bet, causing more and more intense selling.

What’s fascinating, too, is that you had politicians blaming technology. Rep. Ed Markey that previous summer held hearings on “program trading” and its dangers to the market.

Markey is still in the house, though the current crash hasn’t animated him. He’s focused on the BP oil spill right now. Sen. Ted Kaufman is his modern-day equivalent.

But as Pirrong also points out, there is one huge difference between the Flash Crash and Black Monday. The market corrected itself within minutes this time. On October 19,1987, the Dow fell 22% and didn’t bounce back at all. The system, with all its newfangled high-frequency robots trading with each other, didn’t go into total freefall.

The question for regulators is: will whatever they end up “fixing” impede the ability of markets to self-recover? We don’t know, though we do know that the first moves from the exchanges — cancelling trades — is not helpful, as it discourages traders from coming back in.

Given the prevailing mood that the market failed during the crash, rather than worked, we’re not optimistic.

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