The 1987 Black Monday crash and the failure of portfolio insurance

In 1987, Wall Street geniuses thought they had finally "cured" losing money with something called portfolio insurance. It was a computer program designed to automatically sell stocks the moment prices dipped, acting like a high-tech safety net for the wealthy.

But here is the punchline: when the market actually wobbled, every single computer tried to sell at the exact same second. Instead of a safety net, it became a digital stampede where everyone tripped over each other to reach the exit.

The "insurance" actually fueled the 22% crash because humans always think they can automate away their own greed and fear. Spoilers: we can't, and we usually just build faster ways to fail.

Wait, if every computer is selling, who is actually buying those stocks?

That’s the catch—almost nobody was. The 'geniuses' assumed the market was a bottomless ocean for their shares. They forgot that for every seller, you need a buyer who isn't also currently panicking.

When every computer triggered, the human buyers vanished. Prices 'gapped,' teleporting downward because there were zero bids in between. It’s like trying to sell a life jacket on a sinking ship when everyone else is already drowning.

Your exit strategy fails if the door is tiny and ten thousand people are charging it. You aren't 'insured'; you're just part of the pile-up.

So how did the market actually stop falling if nobody was buying?

It didn't stop because the computers got smart; it stopped because the Federal Reserve panicked and promised to flood the banks with cash. They basically told the big players, "Keep trading, we’ll cover your tabs."

Eventually, prices hit a floor where the greed instinct finally kicked back in. Even with the building on fire, some people couldn't resist picking up stocks at a massive discount once the bleeding slowed down.

We later invented "circuit breakers" to force these digital stampedes to take a timeout, but back then, we just had to wait for the adrenaline to wear off and the bargain hunters to crawl out of their bunkers.

But how does a 'circuit breaker' actually force everyone to stop panicking?

Think of it as a mandatory "calm down" room for toddlers, except the toddlers are billionaire hedge fund managers. If the market drops by a certain percentage—usually 7%—the entire stock exchange literally turns off for 15 minutes.

It’s a forced pause designed to snap the "death spiral" of automated selling. It gives humans a chance to breathe, check the news, and realize the world isn't actually ending before they accidentally delete their entire net worth.

Of course, it’s a bit like putting a band-aid on a gunshot wound if the economy is truly rotting, but it prevents that 1987-style glitch where the market vanishes in a single afternoon just because a computer program got the hiccups.

What if everyone just uses those 15 minutes to panic even harder?

Oh, they absolutely do. Sometimes the "calm down" room just gives people 15 minutes to call their brokers and scream louder. That’s why there are levels to this madness.

If the 7% drop doesn't stop the bleeding and it hits 13%, we pull the plug for another 15 minutes. But if it hits 20%? The game is over. The exchange shuts down for the rest of the day, basically sending everyone home to sleep it off.

It’s the ultimate "I’m taking my ball and going home" move. By forcing a global time-out until the next morning, the hope is that the sheer exhaustion of being terrified will finally outweigh the urge to sell.