1987 Stock Market Crash - How a Newbie Beat the Great Crash! - Part 1
Stock-Markets / Financial Crash Oct 19, 2007 - 02:40 AM GMTBy: Nadeem_Walayat
Today is the 20th anniversary of the 1987 stock market crash which is an apt time to go back to the roots of a 20 year successful trading strategy, one that had me short on the day of the great crash! The REAL secrets of successful trading. Okay so you have heard this one many times before in countless books printed by the skip full, but bare with me a while whilst I take a 20 year step back down memory lane, long before I went through my gannophile phase or saw elliott wave patterns and fibonacci golden ratios in virtually every object that my eyes gazed upon.
First Some Key Points
This article concerns trading the markets rather than investing which requires totally different strategies. Also I am writing this article some 20 years after the event relying on memory and the financial records that I have managed to dig out, so my recollection may not be 100% spot on. This aims to be the first of two articles that aims to present my views on the real secrets of successful trading. This part covers the 1987 Stock Market Crash, Part 2 will cover the technical conclusions of how to trade successfully.
The Dawn of my Trading Career
Back in 1986 at the tender age of 18, I wanted to do more than to just invest in shares and watch them grow slowly, the small weekly percentage moves were just not enough. At the time Margaret Thatcher's Conservative Government was eager to buy votes by turning socialists into capitalists and to dish out free cash to their city backers by selling off state industries such as British Gas at knock down prices which meant free instant profits for anyone that subscribed to the shares. Shares issues tend to be capped at x number of shares per individual investor so as to enable as many individuals as possible benefited from becoming part of the Tory capitalist cash hand out dream.
In December 06 just prior to the floatation of British Gas, I was made aware via the media that there existed grey markets in the price of British gas shares, where one could trade the premium between the issue price and the actual price the company traded at on the first day of business. Immediately this drew my interest, as it introduced the concept of gearing in trading. The shares closed up more than 25% on the first day of trading with a large number of the 3,000,000 small shareholders electing to sell and locking in an instant profit. Those trading the gray market would have made an even bigger profit and I wanted to learn more about using leverage to trade.
The city central library was stocked with several basic books on the stock market, and basic technical analysis, i.e. open-high-low-close price charts and moving averages. Where derivatives trading was concerned there were books on the basics of the futures and options markets which appeared to be the way to go.
The next thing to do was therefore to open a trading account with a futures / commodities brokerage firm. Having looked into a number of brokerages I quickly came to the opinion I was just not in their league. The demand was for funding of several thousands pounds PER position i.e. the brokerage firm planned to charge me from between £500 to £900 in commission per position, so very profitable for the brokers but a total rip off for me and probably for anyone else using these brokerage firms. It was just not possible to make a profit under these circumstances regardless of the sales pitch the broker would deliver over the phone.
That led me to the only viable alternative - Traded Options, which 'appeared' to fit the bill as I could actually afford to trade option positions with my meager £700 bank roll. So after some research I opened my first Traded Options account with a Northern Stock / Options Broker and started trading stock options on a full time basis. I played the stock options market for the next 5 months and saw my account shrink from £700 to just £300. Again the only real winner here was the broker that raked in well over a thousand pounds in commission after several hundred trades. If I ever happen upon a successful options trader, then I always tip my proverbial hat, because they are rare breed !
Whilst I had not made any money trading options, I had imprinted valuable lessons into my mind of knowing exactly what I had risked per position and treating that as a total risk against a potential return. Which would prove pivotal mind set in my early years trading as I would always understand as a fundamental ingrained principle of a. That the risk is known before the trade is put on i.e. a stop loss level. b. Never add to losing positions, c. That the potential profit must be greater than the potential loss and to take profits. Those basic money management rules learned through options trading would prove important.
By the start of August 2007, I was back to square one when I happened upon an advert in the Financial Times by IG Index, a spread book maker, which promised to offer the facility of trading the futures markets including the popular stock indices such as the Dow Jones Industrial Averages (for which no market existed at that time) and the UK's FTSE 100 Index. The important points about what IG Index were offering was that I could have exposure to the indexes with miniscule position sizes of as at little as £50 per position ! It seemed to good to be true, so I gave it a shot and signed up. IG Index blew my socks away ! This was even better than i could ever have imagined and exactly what I had been looking for, for nearly 9 months.
The key elements were - a. Small position sizes of as little as £2 per point, b. all of the commission was included in the spread between the buying and selling price and c. IG offered guaranteed stop losses, so that the risk was absolutely controlled, yes you had to pay extra spread for this facility but it was exactly what I was looking for when I put a position on to know the absolute risk against potential reward. Stop losses are a critical element of successful trading, if anyone tells you anything different then they don't know what they are talking about and cannot consistently make money trading! You have to know when you are wrong and the best way is for the market to tell you that you are wrong by stopping you out of your position.
So I opened a £500 trading account in August 1987 and started trading just the stock indices FTSE100, FT30 and Dow Jones Index, as I knew absolutely nothing about the commodities markets. All I had were my trusty hand drawn daily OHLC charts sprinkled with trend lines and support / resistance levels. With no knowledge of anything more I managed to make about £1000 in profit prior to the crash, and was well on my way towards a profitable trading career based purely on short-term positions many of which were just for the day or until the stop loss or profit targets were hit. This allowed me to withdraw £200 a fortnight as an income from profits, more than enough to fund a teenagers lifestyle.
Pre- 1987 Crash - The Great Storm Hits Southern England !
Thursday 15th October - Michael Fish is a Weather Man
I remember watching Michael Fish the BBC weatherman late Thursday night, he said. "Earlier on today, apparently, a woman rang the BBC and said she heard there was a hurricane on the way; well, if you're watching, don't worry, there isn't." Well that statement has haunted the Mr Fish ever since and is a good lasting memory imprint from 1987.
My analysis had expected an up day and therefore the initial position was for the Dow to rally, this was stopped out with a loss of £165. Later in the session I took a chart trigger to go long again which I closed out with a profit of £100, so I ended the day with a small loss of £65. However the earlier downtrend had weakened the Dow and risked a break below the Sept 07 low.
With the winds buffeting the house, some 180 miles north of central london, I eventually decided that tomorrow would be a strong down day for the FTSE given the brewing storm, both weather and financial.
Friday 16th October - The Hurricane Hit Southern England
The News reporting was full of the devastation in the South of England with power cuts in many areas. Also much of the city failed to report to work and hence the UK financial markets were not fully operational.
I called IG index up, half expecting no one to pick up and was pleasantly surprised that they were open for business ! Whilst I waited for the Dow Jones to make up its mind on whether it wants to break the Sept low, I shorted the FTSE twice during the day with the expectation that the unexpected storm would drive stock markets lower, and exited prior to the close with two profit trades of £305 and £30.
I was alarmed by the sell off in the Dow which closed Friday sharply lower, not only decidedly breaking the September low, but the downtrend appeared to be accelerating.
I spent the whole of Friday and Saturday contemplating the change in market behavior and it slowly dawned on me by Sunday that the market was going to crash ! Being isolated from market commentators, I was not aware of the reasons of why it should crash rather that the Market's character had changed.
I was kicking myself for closing the two short FTSE positions by Fridays close! For I concluded that if it was now obvious to me, a newbie to trading that the stock market was going to crash on Monday then it must be obvious to everyone else in the world ! I.e. the experienced futures and stock traders ? Therefore the futures would discount the crash and therefore how can I make any money by shorting the market on Monday's open?
Anyway after resigning myself to more or less having missed the boat, I had decided that I would see if its worth shorting the market on the open, hopefully the futures will not be discounting too much of a drop, may be a hundred points from the spot indices would still enable me to profit from the anticipated stock market crash.
Monday October 19th, 1987 - Stock Market Crash - Pay Day !
Tell me Why I Like Black Mondays
I saw the FTSE open sharply lower, down about 100 points, I sighed and called IG Index and asked for the futures prices, expecting bad news that the futures would be discounting drops of several hundred points for both the FTSE and Dow, but they were NOT ! They were discounting barely a 50 point drop from the spot indices which meant that the market was NOT expecting a stock market crash! I immediately sold the Dow Short at 2247 and the FTSE Short at 2147.
Mid-day (UK Time)- I called the broker and moved the stop losses to lock in profits, which with IG Index means freeing the money for use in further positions. The FTSE was down over 200 points by now with little difference between spot and futures prices so I shorted the FTSE some more at a price of 2047.
2.40pm - Wall Street opens - Well tries to open but the stocks are not opening due to the volume of selling therefore for a while the Dow Jones index is giving a false price of only having fallen a few points, the lull before the storm ? I give IG a ring to find what prices they are offering with a view to shorting some more.:
"Hi could you give me a price for November Dow Please ?"
"Yes Sir, It is trading at 2045"
"Good, I would like to sell to open £5 at 2045, with a 50 point stop"
" You want to sell ?"
"Yes Sell", maybe he thought I was already too heavily short ? Perhaps people were to scared to short the Dow ? I don't know, but the impression I got was of surprise.on the other end of a line.
So that was my fourth short opened for the day at 2045, meanwhile the actual Dow Jones spot indication was down only 50 points at about 2,200 due to slow opening of individual stocks against the actual futures nearly 150 points lower !
7.40pm - The Dow is now down about 300 points,having rallied from about 340 down about 10 minutes earlier. Having watched the market for the last 5 hours, I get the feel that its gearing up for another bout of selling towards being 400 down, so wanting to sell more I give IG Index a call.
"Hi, can you give me a price for November Dow please".
"Mr Walayat, we are only accepting orders to CLOSE "
Damn !!! On a £10 per point I could have made another grand on the target of 400 down by the close.
8pm - The Dow is hovering around 300 points down with an hour to go, this is nail biting time! - I can't stand this as I cannot sell short any more and and I do not want to liquidate, so I go out out for a drive and return when the US markets have closed at 9pm.
9pm - BBC 9'0 Clock News - Dow Jones closes down 508 points at 1739 !!! cough, cough splutter, 508 , FIVE HUNDRED AND EIGHT POINTS !!
Wow ! I am rich ! rich, RICH - How much ? £14,000 at least ! From an account balance of £700 to £14000 in one day ! Okay in today's money £14,000 is not a lot to shout about, but to a 19 year old in 1987, £14,000 was an enormous amount of money especially as it was made in one day ! As an example I could have bought a terraced house in the street for about £14,000!
Now what to do next ? No time or inclination for sleep, I need to work out what to do tomorrow as clearly the FTSE is going to open sharply lower! This looks like a complete and utter collapse of the financial system - 508 points down ! Not in my wildest imagination could I see the Dow Jones closing down 508 points, this crash is bigger than that of 1929! Which was about 10%, not 22% in one day!
I decide to close the positions tomorrow during the morning, I have made the paper profits and now to lock them in.
Tuesday 20th October 1987 - Big Bounce Day
The FTSE opens sharply lower and trades down by over 200 points by mid-day. Having watched the market trend lower, and having withheld on my decision to liquidate any of the positions thus far, I am absolutely exhausted by now due to not having slept in over 24 hours and actually starting to get dizzy so I give the broker a call to get some prices with the aim of liquidating all of the positions whilst I am still mentally able to do so without starting to hallucinate figment price action!
IG is giving me a quote of 1720 for the FTSE and 1570 for the Dow 30. These are excellent prices, so I decide to close the larger Dow position at 1570. And move the stops on the other three positions. I set the FTSE position stops at 1790 and 1800, and the remaining Dow short position stop at 1730, i.e. just below last nights close, and 160 points above the current futures price.
Wall Street Opens Sharply Higher and I am stopped out of all positions. Exhausted, I was off to bed.
The Outcome
In financial terms, I made a profit of about £12,300 virtually overnight. In EGO terms the increase was much larger!, I was off floating into fantasy land of becoming a millionaire by the time I hit 20 ! What actually transpired ?, well that's another story.
Following the stock market crash speculation was rife that some of the financial institutions may go bust , worried that my new found wealth my evaporate I withdrew more than 50% of the funds on account on the 23rd of October 1987.
An Historic Marker is SET
Of all that has come to pass during the subsequent 20 years of my trading life, one major advantage I have had that many traders have not is a clear marker against which to compare methodology and trading psychology. It may not have always been clear in the midst of the search for the holy grail of trading and analysis, but I have always had the option of referring back to what proved itself to work.
Proof
Okay so you have read my account of trading the 1987 Crash and are now probably wondering, how about some proof? Well in that regard see the scans of the 1987 contract notes / statement from IG Index. I have yet to locate the actual hand drawn price charts, which I hopefully will and attach to this article or seek to include them in Part 2.
1987 Statement and Main Contract Notes / Position closures
19-10-07 - Dow Short 2227 - Open
19-10-07 - FTSE Short 2147 - Open
19-10-07 - FTSE Short 2047 - Open
19-10-07 - Dow Short 2045 - Open
20-10-07 - Dow Short 1570 - Close - Profit £6,570.
20-10-07 - FTSE Short 1790 - Close - Profit £2,124.
20-10-07 - FTSE Short 1800 - Close - Profit £1,799.
20-10-07 - Dow Short 1730 - Close - Profit £1,575.
October 1987 Trading Statement
Look out for Part 2 in the coming week - The REAL Secrets of Successful Trading
By Nadeem Walayat
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Nadeem Walayat has over 20 years experience of analysing and trading the financial markets and is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 100 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk
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