So what happened in 1987?
- The crash followed a recent move down from all-time highs made a couple of months earlier;
- There was an international situation which contributed to the price move - in this case, it was the spat between James Baker and the Germans;
- Price accelerated to the downside throughout the week, culminating in a big drop on the Friday on heavy volume.
What is happening now:
- The market has moved down from all-time highs made as recently as the middle of May on the Dow, mid-June on the Russell 2000 and mid-July on the Nasdaq;
- There are international situations which may or may not have contributed to price falling - Greek PM resigning, China trying to prop up its own stock market, devaluation of the Chinese Yuan;
- Price accelerated to the downside throughout the week, culminating in a big drop yesterday on heavy volume.
It's been noted by a few traders that the price action in the Dow for the current year to date had been compressed into its tightest ever range (in percentage terms), compared to previous years. People who have read this blog for a while will also know that I talk about a contraction in volatility preceding an expansion in volatility, likening it to the coiling of a spring before a big release of energy. Is that what is happening here? Possibly.
Over the last few weeks I've found it extremely difficult to find any decent setups on stocks which match my criteria, hence the lack of trading activity. In addition, I was gradually taken out of what positions I had. In his book, Nicolas Darvas talked about something similar happening in the early 1960's, which preceded a drop in the markets - he didn't know what was going to happen, but he simply followed his rules.
It is interesting reading the various interviews in Market Wizards and those traders' own experiences of the '87 crash:
"Most trend traders were likely either out or short stocks and stock indexes during the crash" - Ed Seykota
"It looked climatic to me, and I thought that was a buying opportunity. The only problem was that it was a Friday. Usually a down Friday is followed by a down Monday." - Marty Schwartz
Stanley Druckenmiller switched from being net short to net long on the Friday before the crash. On the other hand, Jim Rogers was already positioned for a crash. "I was in a panic, and I was already short!"
I'm not predicting that there will be a crash on Monday. All I have done is followed my rules which have taken me, and kept me, out of the stock market. I've absolutely no idea what will happen over the coming days. But the trend that is starting to develop is suggesting that price will be continuing to move downwards.
So, is this time different? Maybe. Maybe not. For one thing, there are circuit breakers in place to prevent such a huge fall (in percentage terms) from happening now. But I guess 99.9% of people who will read this post weren't trading back in 1987 - hell, many of you probably weren't even alive!