1987 Black Monday: An Analysis of a Market Crash through the Elliott Wave Principle
1987 Black Monday: An Analysis of a Market Crash through the Elliott Wave Principle
1987 Black Monday: An Analysis of a Market Crash through the Elliott Wave Principle
ABSTRACT
This study examines the crash of the S&P 500 index in October 1987 within the framework of the Elliott Wave Principle. Pre-crash wave counts indicated that this movement represented the IVth Wave of Cycle degree. Analyses reveal that the crash was not an exaggerated crisis but rather a natural corrective movement anticipated by the wave principle. Post-crash evaluations indicate that the trend resumed from where it left off, continuing the market's long-term bullish trajectory. The study highlights the predictive power of the Elliott Wave Principle in understanding market movements.
1. INTRODUCTION
The crash of the S&P 500 index in October 1987 made a profound impact on the financial world and is widely referred to in the literature as "Black Monday" (WSJ, 2022). In a short period, the market lost over 30% of its value, triggering similar declines in global markets. However, was this crash merely a crisis, or was it a natural part of a broader cycle?
The Elliott Wave Principle interprets market movements within the framework of natural cycles and explains price actions as a series of waves. In this study, the waves observed in the S&P 500 index before and after the 1987 crash are analyzed in detail, identifying the crash as the IVth Wave of Cycle degree during a bullish season. The continuation of the trend in the same direction post-crash supports this view. Consequently, the 1987 crash is reinterpreted as part of the inherent fluctuation process within the market's nature.
2. LITERATURE REVIEW
Academic studies on fluctuations and crises in financial markets have developed various theories to understand and predict market movements. Among these theories, the Elliott Wave Principle holds a significant place and serves as an effective tool for analyzing market cycles.
Karthikeyan and Chendroyaperumal (2011) evaluated the October 1987 crash as a major market movement and argued that this crash was a natural consequence of fluctuations within the financial system. Their study discussed how markets could be anticipated using fundamental and technical indicators.
Gunn (2009) described the Elliott Wave Theory as one of the most comprehensive investment approaches in market analysis, capable of accounting for all timeframes and regimes of price movements. Additionally, he highlighted that the method offers a highly holistic system for investment analysis.
In his thesis, Hayashi (2002) stated that Elliott Waves function as a technical analysis system that helps forecast market predictability. The system provides information indicating the proximity of trend changes while also determining the potential direction, target price, and timing of movements.
Frost and Russell (1996) emphasized that the wave principle is a rational theory.
Russell (1976) noted in his study that the wave principle is largely based on the Fibonacci sequence.
Beckman (2014) stated that once a distinct wave set is identified, the timing and magnitude of these waves can be predicted using specific rules and classification methods. He further indicated that each new wave affects price movements and determines the formation of subsequent waves, suggesting that every completed wave establishes a foundation for the waves that follow.
3. FINDINGS:
1st Wave: The Beginning of the Uptrend (September 30, 1974 – September 20, 1976)
The uptrend that began after the market reached its bottom on September 30, 1974, marks the formation of the first wave according to the Elliott Wave Principle. This period represents a phase where prices recovered from their lows and gradually started to rise. The 1st Wave typically signifies a time when investors overcome their fears and begin to regain confidence in the market.
During this wave, the initial signs of a bullish season become evident, and prices progressively increase. The uptrend continued until September 20, 1976, creating a robust first wave formation. This phase indicates a general trend reversal in the market and the emergence of upward momentum.
2nd Wave: Retracement (September 1976 – February 1978)
Following the completion of the 1st Wave, the market entered a retracement phase identified as the 2nd Wave. This corrective movement, which spanned from September 1976 to February 1978, was marked by a decline in prices aligning with Fibonacci retracement levels.
An examination of Fibonacci levels reveals that prices retraced to approximately 38.2% (0.382) and 50% (0.50) levels. Such a retracement is a characteristic feature of corrective waves and reflects a period of indecision among investors as they reassess market conditions. However, this type of pullback at Fibonacci levels can also be interpreted as a preparatory phase for a new bullish season.
By February 1978, the 2nd Wave concluded, and the market transitioned into a strong bullish phase. According to the Elliott Wave Principle, the uptrends that follow corrective waves typically result in more pronounced and robust trends. In this context, increasing confidence and optimism among market participants fueled a rapid rise in prices.
The subsequent analysis examines the period between March 1980 and 1984, focusing on the waves of Supercycle and Cycle degrees.
Supercycle Degree (II) Wave: November 1980 – August 1982
The (II) Wave, which followed the (I) Wave, marked a retracement period lasting from November 1980 to August 1982. According to Fibonacci levels, this correction extended to the 61.8% (0.618) retracement level. The correction took the form of an ABC zigzag pattern, indicating a brief consolidation phase in the market.
Notably, the C wave developed within a terminating diagonal formation, highlighting the complex structure of the retracement process. Such formations typically signify the nearing conclusion of a correction and indicate a likely upward reversal in the trend.
Cycle Degree I Wave: August 1982 – Summer 1983
The Cycle Degree I Wave began in August 1982 and ended in the summer of 1983. This wave reflected the market's strong recovery following the correction and the reestablishment of investor confidence. This period was characterized by a robust upward trend in prices, signaling a resurgence of market optimism and momentum.
Cycle Degree Wave II: Summer 1983 - July 1984
The Cycle degree Wave II began in the summer of 1983 and concluded in July 1984. This corrective movement retraced 38.2% (0.382) according to Fibonacci levels. Being relatively shallow, this correction indicated that the market maintained its overall upward momentum, laying the groundwork for a prolonged bull market. Following the end of Cycle Wave II, Cycle Wave III commenced with a robust upward movement, marking the onset of a strong bull trend characterized by increased momentum and peak investor confidence. The Fibonacci extension level for Cycle Wave III rose as high as 2.618 times that of the preceding Cycle Wave I, reaffirming the reliability of Fibonacci levels as a guiding tool.
Internal Structure of Cycle Wave III:
Primary Wave 1: Summer 1984 - Summer 1985
Primary Wave 1, beginning in the summer of 1984 and continuing through mid-summer 1985, represented the initial phase of the bull trend. This wave fostered an atmosphere of optimism among investors.
Primary Wave 2: Summer 1985 - September 1985
Following the first wave, the second wave indicated a corrective phase within the market, concluding in September 1985. This phase laid the foundation for a stronger third wave.
Primary Wave 3: September 1985 - Summer 1986
The third wave, from September 1985 to the summer of 1986, is typically the most powerful and longest wave. High trading volume and rapidly rising prices defined this phase, which embodied the essence of a strong bull market.
Primary Wave 4: Summer 1986 - Autumn 1986
The fourth wave, a corrective wave, partially retraced the gains of the third wave without altering the overall bullish trend. A notable alternation occurred between the second and fourth waves, with the latter experiencing a sharper retracement compared to the former.
Primary Wave 5: Summer 1987
The fifth wave marked the peak of the bull trend, concluding in the summer of 1987. With the completion of this wave, Cycle Wave III also came to an end.
Cycle Wave IV: Projections and Retracement
Cycle degree Wave IV naturally followed the completion of Cycle degree Wave III. According to Elliott Wave Principle, second and fourth waves tend to exhibit contrasting characteristics. Since Cycle Wave II retraced 38.2% (0.382) according to Fibonacci levels, it was anticipated that Cycle Wave IV would retrace to the 61.8% (0.618) level. When second waves are shallow and horizontal, fourth waves often exhibit sharper corrections, and vice versa. In summary, the 1987 market crash (Black Monday) can be viewed as a reflection of Cycle degree Wave IV, representing a natural corrective phase in the market.
As observed in the graph, the bull market that began in the final months of 1990, corresponding to the higher-degree blue Wave 3, continued until September 2000.
In the chart below (Chart Link), the consolidation period starting in September 2000 and lasting until March 2009 is illustrated. This period includes two significant crises: the 2001 crisis and the 2008 financial crisis.
In 2001, the United States faced a significant economic downturn. Known as the "dot-com bubble," this period saw a dramatic collapse in the stock market due to the overvaluation of technology companies. As tech stocks experienced sharp declines, investors panicked, and the U.S. economy entered a recession. Furthermore, the September 11, 2001, terrorist attacks exacerbated economic uncertainty. Companies cut back on spending, unemployment rose, and the Federal Reserve attempted to stimulate the economy by lowering interest rates. However, the fear in the markets did not dissipate immediately. As a result, 2001 was far from a stable year for the U.S., leaving long-lasting impacts on financial markets.
However, this crisis corresponded to the A wave within the blue Wave 4 (Flat structure) and consisted of three internal forms. It is also expected that the B wave would take on a three-wave structure since Flat patterns are typically formed in a 3-3-5 configuration. The diagram below provides a clearer view of how the Flat structure forms:
The 2008 crisis, on the other hand, was triggered by the bursting of the U.S. subprime mortgage bubble. Banks issued high-interest mortgage loans to individuals with poor creditworthiness. Trusting in the continuous rise of housing prices, banks securitized these loans into financial derivatives and sold them globally. However, as real estate prices fell, many borrowers defaulted, rendering these financial products nearly worthless. Major banks and insurance companies approached insolvency, prompting governments to intervene with bailout packages. The collapse of Lehman Brothers in the U.S. further escalated the crisis. This turmoil spread worldwide, leading to a global economic downturn and rising unemployment.
According to the Elliott Wave Principle, the financial crisis during this period represents the C wave. Consequently, the crises and collapses experienced from 2000 to 2009 formed the blue Wave 4 within a Flat pattern. Therefore, these declines were anticipated within the broader wave structure.
4. DISCUSSION
In the discussion section, the October 1987 crash of the S&P 500 index, commonly known as "Black Monday," is evaluated in light of the analyses presented in the findings section. Within the context of the Elliott Wave Principle, this assessment emphasizes that market movements should be viewed not as crises, but as a natural part of the market cycle.
According to the findings, pre-crash market movements were identified as part of the Cycle degree Wave IV. This wave represents one of the corrective phases inherent in market dynamics, which is essential for the healthy continuation of the preceding trend. The market’s loss of more than 30% of its value highlights both the depth of this corrective wave and its psychological impact on market participants.
The Elliott Wave Principle suggests that such movements occur in an orderly manner and are often associated with Fibonacci ratios. The findings indicate that Wave IV retraced to the 61.8% level, a ratio frequently observed in corrective waves. Furthermore, the retracement of Wave II to the 38.2% Fibonacci level provided a predictive basis for the retracement depth of the subsequent Wave IV. This alternation, where one wave is horizontal and the other more pronounced, reinforces the predictive reliability of the theory.
The analyses in the findings section reveal that each wave reflects the emotional responses of market participants. For instance, the retracement during Wave IV induced fear and uncertainty among investors, yet this period ultimately laid the groundwork for a new upward trend. The bull market observed after the correction demonstrates the dynamic nature of the market and its alignment with wave principles.
The 1987 crash should be interpreted as a natural outcome of market cycles. The data presented in the findings section demonstrate that this crash was merely a reflection of market dynamics and did not alter long-term market trends. This reinforces the reliability of the Elliott Wave Principle as a tool for market analysis. The overarching framework of this discussion aligns with the analyses in the findings section, underscoring the predictable and cyclical nature of market movements.
5. CONCLUSION
This study examined the 1987 "Black Monday" crash of the S&P 500 index within the framework of the Elliott Wave Principle, revealing significant insights into the natural cyclical structure of market movements. The findings demonstrate that this crash was consistent with a corrective movement of Cycle degree Wave IV, supporting the predictable nature of market cycles.
The analyses highlight that the emotional responses of market participants are clearly reflected in price movements and align with the forecasts of the Elliott Wave Principle. The continuation of the bull trend following the crash further validates the theory's effectiveness in understanding long-term market movements. Moreover, the influence of Fibonacci ratios on wave structures has reinforced the regularity of market cycles and the practical applicability of the wave principle.
In this context, the Elliott Wave Principle is evaluated as a robust tool for analyzing financial market cycles and forecasting future movements. The 1987 crash serves as a critical example in understanding the natural cycles of financial markets, demonstrating the theory's academic and practical value. The study's findings underscore the importance of theoretical models in comprehending market dynamics and supporting strategic decision-making processes.
For further insights into future trends in the S&P 500 index, visit www.ew-strategy.com !
6. REFERENCES
Beckman, R. C. . (2014). Super Timing: The Unique Elliott Wave - Keys to Anticipating Impending Stock Market Action (2nd Edition). Harriman House Ltd.
Chendroyaperumal, C., & Karthikeyan, B. (2011). Empirical Verification of Elliott Wave Theory in Indian Stock Market. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.1887789
Frost, A. J., & Russell, R. (1996). The Elliott Wave Writings of A.J. Frost and Richard Russell, Edited by Robert R.Prechter, Jr. New Classic Library.
Gunn, M. (2009). Elliott Wave Principle. John Wiley & Sons Ltd. https://doi.org/10.1002/9781119207801.CH8
Hayashi, A. D. (2002). APLICAÇÃO DOS FRACTAIS AO MERCADO DE CAPITAIS UTILIZANDO-SE AS ELLIOTT WAVES Dissertação de Mestrado.
Russell, R. (1976). The Elliott Wave Principle in Richard Russell’s Dow Theory Letters: Russell on Stocks & Bonds. Dow Theory Letters.