Tuesday, October 20, 1987 p. 39
By Al Gordon
The computer age has made it possible for Wall Street traders to make more, and more complicated, trades than their counterparts in 1929. And as a result, the stock market has been left vulnerable to an even more cataclysmic collapse than 1929's Great Crash.
Market analysts said that computerized trading techniques have helped accelerate the Wall Street slide that started more than two weeks ago and led to yesterday's unprecedented 508-point, 22.62-percent drop. On "Black Monday," Oct. 28, 1929, the Dow lost 12.8 percent.
John Phelan, chairman of the New York Stock Exchange, said yesterday that the market's collapse was the kind of financial "meltdown" he long has been warning might result from computer trades.
One element of the situation is the sheer ability of computers to handle enormous volumes of transactions. A total of 604.4 million shares changed hands on the New York Stock Exchange yesterday, almost twice as many as ever before in a single day.
The volume alone "is a testament to computers," said Joseph Schmuckler of Kidder Peabody. "You could not process or disseminate this kind of volume without computers."
But beyond that, computers have allowed large institutional investors to implement exotic mechanisms to hedge their bets: program trading and so-called "portfolio insurance."
Both essentially work by playing off the value of stocks against stock index futures contracts - investments tied to future values of stock indexes, usually the Standard & Poor's 500.
Program trading basically means using a computer to compare stock and futures prices and shift investments to whichever one is offering the best opportunity for gains. Analysts have attributed the market's volatility in recent months to such tactics.
More important to the current slide, however, has been portfolio insurance, analysts said.
This isn't "insurance" in the normal sense of buying coverage against a loss, but rather the name given a trading tactic. It's a hedge against a falling market under which an institutional investor sets in advance a number of criteria for bailing out of the stock market and programs the computer to execute the retreat. Part of the technique is to use gains from trading of stock index futures to limit losses from stocks.
Because the market had been a raging bull for most of the year, this tactic hadn't been used much. But once prices started to tumble earlier this month, said Jeffrey Miller of Miller, Toback, Hirsch & Co., these mechanisms were triggered. "No one expected it to come into play with such a vengeance," Miller said. He estimates that $70 billion in assets are tied up in such "insurance" programs.
Bill Marcus of Donaldson Lufkin & Jenrette said that it would be a mistake to attribute yesterday's crash entirely to such tactics. The selling pressures were more widespread than that, he said. But he and other analysts said that computer trading maneuvers clearly had helped push the market down for the last two weeks, thereby setting the stage for yesterday's panic.
Copyright 1987, Newsday Inc.