This price shock will probably change the average motivation from greed
to fear. If the market doesn't bounce back fairly quickly, investors
will realize that it is no longer a sure thing, and they will want to
protect the profits they have made so far. They will do so by selling,
which will further drive down prices.
One interesting difference from the 1987 crash is the use of trading
halts. This was a controversial measure put into place after that crash.
The idea is that the crash is motivated by irrational panic, and that by
halting trading for a while, reason will return. It's an unusual theory
because it is based on the assumption that investors are irrational,
which is contrary to the assumptions generally used in analyzing markets.
A lot of people opposed these holds because they depart from the idea of
a free and efficient market, and they seem like attempts to legislate
away the natural process of fluctuating prices. But in the aftermath of
the 87 crash people felt like they had to do something.
Today, the market fell about 200 points, and so they put in a 30
minute hold. As soon as the hold was lifted it fell even faster.
People said it almost seemed like the hold just gave people time to get
more sell orders in. Finally, the market was shut down 45 minutes early.
Otherwise the drop, a record in terms of points lost in one day, would
have been even worse.
It could be that these holds and shutdowns may make the psychological
factors even worse. If the market is falling, at least you can assume
that at any given moment the valuation approximately reflects people's
views. Actually, of course, during a rapid drop like today the market
may lag behind, but generally at the end of the day you can expect that
the next day could see some improvement. But when you know that the only
reason the market didn't fall more was because of an artificial hold,
you can be practically certain that this will generate more pent-up
selling pressure. The holds end up increasing fear and uncertainty
because you no longer can assume that the market is clearing and
reflecting people's opinions.
I don't think now is a good time to buy. Although recent drops have
been followed by quick recoveries, I don't think that will be the case
this time. It should be possible to get a much better deal in a few
months, although by then the psychology will have turned so that no one
will be very excited in stocks at that time (which is itself a time to
start buying).
Hal