What's up guys and welcome back to wall street millennial on this channel, we cover everything related to stocks and investing in today's video we're going to take a look at one of the most interesting market events in history and one of the greatest trades that ever happened As a result, in 1987, black monday saw stock markets across the globe experiencing credible drawdowns the dow and the s p, 500 indices both fell by more than 20 in a single day, significantly more than the worst single day in the coronavirus sell-off, the selling was so Violent that it broke the systems of the new york stock exchange and the nasdaq when the dust settled trillions of dollars of value had been wiped out. It took two years for the markets to fully recover to their previous highs, but the strangest part of it all was that didn't seem to be explained by any external or geopolitical event. Instead, it was more of a psychologically motivated wave of selling that caused a feedback loop, pushing prices ever lower. The selling was aggressive across the board on that day, but for those who were prepared, it presented a tremendous opportunity.

One young investor who predicted that the crash would happen, made 100 million dollars as a result tripling his money. His name was paul tudor jones, a man who made one of the greatest trades of all time, leading up to the 1987 crash. The stock market was having an insane hot streak. The s p 500 index rose from 100 points in 1982 to 330 points in 1987, more than tripling in just five years.

That's a compounded annual return of 27 percent over five years in comparison over the last five years. The s p has gone up by a little more than double and that's been considered. One of the greatest bull runs ever so leading up to 1987 was even more also. During that time, the volume of trading activity in the stock market consistently rose, it approximately doubled from 1982 to 1987..

This suggests that there was a level of exuberance and increased interest in the stock market. At the same time as the market was making huge gains, a lot of people were making a lot of money around the same time. Paul tudor jones was running. His new small hedge fund called tudor investment corporation.

He started the fund in 1980, after graduating, from college and working as a broker for a few years he specialized in commodities and futures and used both fundamental analysis and technical analysis to guide his trading leading up to 1987. He perceived that the markets were getting. Perhaps a little too exuberant, there was a lot of leverage being taken out by investors to gain exposure to stocks. Also, he realized that the chart of stock prices over the 80s closely resembled the chart of stock prices from right before the great depression.

The similarity was shocking at the time he as well as two other hedge fund managers. George soros and stanley drunken miller used this as a sign that a crash would soon come paul. Tudor jones knew that the irrationality of all types of markets can lead to huge swings in prices, especially down stock and futures markets at the time did not have as advanced circuit breakers as they do today. Jones felt that this created a situation where it was just a disaster waiting to happen, especially when combined with something called portfolio.

Insurance crash of 87 was really interesting, just because the crash of asm probably never would have happened, except for again uh the market infrastructure. At that point in time, um, i remember because i started out in 76 trading commodities and so for 120 years all commodity futures had limits - and i remember so many times in the late 70s early 80s, where the cotton market would be limit up or the soybean Market would be limited up, because that was the allowable amount, that prices could move and they would not let them go anymore because they knew the irrationality of human nature and the and the possibility of what a mob can do to anything um. So they had limits. Now financial futures come along.

Here's a funny story. You know i tried to work for goldman in 1984. uh when y'all were first starting when y'all were first thinking about futures and they went ah, that's my future's. No, no! No we're not listen.

I couldn't get another. We're not gon na do that, because we're going we're not gon na be in that i didn't get a job at goldman. I only got a job at jay, aaron, okay, jay aaron was bought by goldman. That's right, yeah right, that's right! So anyway.

What is it with these goldman guys stuck up incredibly inflated, but anyway uh so 87? There were no limits. There were no limits on any financial futures, it was just a. It was an absolute accident waiting to happen, and then they started portfolio insurance and in 87 you could just look on any kind of historic, historical metric and see the stock market was stupidly, overvalued tenure rates were 10 and a half percent, and i think the dividend Yield on the stock market was about four and a half or five, so just think about that. Compared to today, right 500 basis, point we'd have would have tenure rates right now, it's something like uh, seven and a quarter, seven and a half the forward prices of stock would have been allowed exactly, but they weren't then, and so, when the market finally broke, i Mean the one thing that that's that i would say: i've learned the past 40 years.

Is these you know price patterns and and price stories this it's the same old story so often just just with different characters, different times different plots, and so that looked a lot like 1929 to me, and i knew for a fact that if and when it broke, Because of the derivative structure that the downside was going to be unlimited, literally unlimited uh, because there were no limits on futures - and i would kind of - i would kind of liken it to this past february's market break. We had that kind of what was that. Was it a seven or eight percent in one week, and you had all the big ctns you had all the short vic structures, those were just, and that was just a bomb ready to explode. That was just a matter of time and that entire break in the first week of february was all derivative inspired.

And, if i think of some of the greatest financial crisis, the last 30 years, they generally speaking, are derivative. Inspired because that's where all the leverage is leverage right in the years leading up to 1987 economic conditions deteriorated slightly tax advantages of corporate buyouts, including the ability to deduct interest expenses associated with leveraged buyouts were eliminated. Also, global interest rates were rising and there were concerns of the return of inflation in the u.s, but perhaps the most important factor in setting the stage for the 1987 market crash was the advent of programmatic trading. In 1980s, a huge amount of computerized training programs were created to automatically take advantage of market opportunities.

Two particular automated strategies have been referenced in relation to the crash. The first was a type of more sophisticated stop-loss strategy called portfolio insurance in this strategy systems would protect the downside of a portfolio by selling when certain market conditions were met, especially when there were large market declines. This contributed to a positive feedback loop whereby selling could induce further selling spiraling out of control. The second strategy was index arbitrage.

This strategy took advantage of any mispricings between the price of derivatives on indexes and values of the constituent stock prices. These systems automatically bought or sold the index or the constituents whenever sufficiently large, missed pricings occurred. This strategy contributed to extreme trading volumes whenever volatility picked up and also perpetrated selling in futures markets into the stock markets. During the week of october 12th, the market started to sell off on news that tax advantages to mergers were going to be wiped out and news that the us's trade deficit had increased.

This selling triggered the automatic stop-loss-like strategies which accelerated selling throughout the second half of the week. Much of the selling was happening in the futures markets and, as a result, index arbitrage programs subsequently bought futures and sold stocks. This led to a steep decline in stocks on friday. In total, the s p was down 9 that week, but that was just the tip of the iceberg.

Over the weekend, an immense amount of selling sentiment built up, especially among the programmatic traders, when the markets opened the following monday, there was so much selling pressure and so little buying pressure that many market makers refused to make markets in their stocks. This led to jumps downward in prices at some point. During the day, there was speculation that the sec would jump in to temporarily halt trading. This news just made traders more anxious to dump their positions before the halt.

All the while the automated trading systems were still selling everything. There was so much selling activity that the new york stock exchange, and especially the nasdaq were overwhelmed. Sometimes trades wouldn't be confirmed for more than an hour after they replaced. Another factor that contributed to the cycle of selling was margin calls many futures traders were unable to meet margin, requirements on their highly leveraged positions when the market crashed and were thus liquidated.

This contributed to even more selling on black monday. The chicago mercantile exchange saw record margin calls about 10 times the average size it got so bad that it was speculated that the exchange would lose solvency. The carnage in the futures markets spilled into the rest of the markets through index arbitrage trading systems. Paul tudor jones ingeniously had sold all of his stocks by this time and was even short the market.

When the crash happened as a result of the crash, he was able to triple his funds money. This led to a more than 100 percent gain for his clients. Even after his high management fees. His hedge fund, pier stanley, drunken miller, whom paul tudor jones had warned about the market crashing beforehand, was able to aggressively sell his stocks when the crash first started happening and thus avoided some of the most extreme losses.

But the fact that paul tudor jones was able to completely avoid and actually profit massively to the tune of 100 million dollars propelled him into the stardom as one of wall street's greatest investment managers, alright guys that wraps it up for this video. If you enjoyed this content, make sure to smash that, like button and subscribe for future content, also leave a comment saying what you think about paul tudor jones's reasoning for predicting the market crash in the meantime. Thank you so much for watching and we'll see in the next video wall street millennial signing out.