How Warren Buffett Reacted to the 1987 Flash Crash

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    Warren Buffett Speaks

    The Dow Jones Industrial Average dropped around 1,175 points in a single day and it was the largest point fall in intraday trading ever.

    While this was the DOW’s most substantial drop in terms of points, it was not the largest percentage loss. It did not even come close. The crash of 1987 still holds the record for the most significant percentage loss when the index lost around 22% in a single day.

    Considering this fact, it would be interesting to go back and look at what Warren Buffet, the most well known investor, was saying to his shareholders in 1987 when the world shocked by the most significant stock market crash of all time.

    Buffett did not devote much of his 1987 letter to investors to the crash. He is well known for being a long-term value investor and doesn’t bother to speculate on short-term market movements or worrying about what the market is saying.

    Buffett said, “During 1987 the stock market was an area of much excitement but little net movement: The Dow advanced 2.3% for the year. You are aware, of course, of the roller coaster ride that produced this minor change. Mr. Market was on a manic rampage until October and then experienced a sudden, massive seizure.  We have ‘professional’ investors, those who manage many billions, to thank for most of this turmoil. Instead of focusing on what businesses will do in the years ahead, many prestigious money managers now focus on what they expect other money managers to do in the days ahead. For them, stocks are merely tokens in a game, like the thimble and flatiron in Monopoly.”

    There are many similarities between the market environment Buffett descibed above and the market right now. The recent past and latest volatile markets are a result of over-leveraged volatility traders, high-frequency trading and algorithm-driven investment strategies. These big players dominate with billions of dollars that can create significant movements in prices, but does this mean the average investor can still play? Yes, even with big players in the market, investors can still take advantage of these swings in prices.

    Buffett said, “Many commentators, however, have drawn an incorrect conclusion upon observing recent events: They are fond of saying that the small investor has no chance in a market now dominated by the erratic behavior of the big boys. This conclusion is dead wrong: Such markets are ideal for any investor – small or large – so long as he sticks to his investment knitting. Volatility caused by money managers who speculate irrationally with huge sums will offer the true investor more chances to make intelligent investment moves. He can be hurt by such volatility only if he is forced, by either financial or psychological pressures, to sell at untoward times.”

    Volatile markets present opportunities and as long as you remain disciplined in your value investment strategy, the big investors should not be able to push the little investors around. Don’t worry about what Buffett calls Mr. Market.

    Buffett said, “But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game. As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.'”

    I can sum up Buffett’s advice for turbulent times in four words:  Stick to the plan!  If you want to be a successful investor, then you need to ignore all of the stock market commentators. Mr. Market is there to serve you and not to guide you. The best way to ignore Mr. Market is to know your investments inside and out and have enough understanding of the business and its valuation to be sure you have made the right decision, even if the stock drops 50%.  You will have less fear and worry if your money is invested in what you know and understand.  And when the price drops of the stocks you carefully selected, if you know its value, then you can buy the dips with confidence.

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    The founder of Trading News Now (TNN) and contributor to the stock market trading community. Graduated from Brigham Young University - Idaho with a degree in financial economics. Aside from his extensive knowledge in fundamental analysis of publicly traded companies, other interests include programming and financial modeling.