How then do you explain the extreme nature of the October 19 price break? The problem that led to the October 19 collapse was the combination of relatively modest real world changes
and an inability of the markets' mechanism to deal with the institutional changes that occurred mostly during the
1980s. The elements of stability—the individual investor and the specialist system—had been greatly reduced in
importance.
Do you believe portfolio insurance exacerbated the decline? [Portfolio insurance is the systematic sale of stock index futures to reduce the risk exposure in a stock portfolio as prices decline. See Appendix 1 for more detail.] That was one of the new elements. On one hand, you had a reduction in the elements of stability. On the
other hand, you had the creations of the 1980s—portfolio insurance, program trading, and global asset allocation—
which tended to exert a unidirectional impact. By that, I mean that participants in these strategies tend to be buyers
and sellers at the same time. The stock market was not prepared to handle it.
Where were you, position wise, coming in on October 19? I came in very much long exposed—80 to 90 percent—and I increased my exposure during the day.
Why? Were you still bullish? My increasing exposure was strictly a contrarian trade in the sense that when the markets have an enormous
move, most of the time, it is right to take the view that there is a lot of emotionalism and extremism in that move. If
you can maintain a bit of distance from the emotionalism, you tend to do well. So my buying that day is what I would
have done on any 300-, 400-, or 500-point down day.
Did you stay with your long position? No, I reduced it throughout the next two months. The magnitude of the decline and the extraordinary change
in confidence that it engendered affected me as well. I thought it was better to sit back and rethink the situation with
a lot of cash rather than try to hang in.
