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A Brief History of U.S. Stock Market Crashes (Causes, Costs, and Results)

The Crash of 1929

On September 4, 1929, the stock market hit an all-time high. Banks were heavily invested in stocks, and individual investors borrowed on margin to invest in stocks. On October 29, 1929, the stock market dropped 11.5%, bringing the Dow 39.6% off its high.

After the crash, the stock market mounted a slow comeback. By the summer of 1930, the market was up 30% from the crash low. But by July 1932, the stock market hit a low that made the 1929 crash. By the summer of 1932, the Dow had lost almost 89% of its value and traded more than 50% below the low it had reached on October 29, 1929.

Causes of the Crash:

  1. Overvalued Stocks. Some analysts also maintain stocks were heavily overbought;
     
  2. Low Margin Requirements. At the time of the crash, you needed to put down only 10% cash in order to buy stocks. If you wanted to invest $10,000 in stocks, only $1,000 in cash was required;
     
  3. Interest Rate Hikes. The Fed aggressively raised interest rates on broker loans;
     
  4. Poor Banking Structures. There were few federal restrictions on start-up capital requirements for new banks. As a result, many banks were highly insolvent. When these banks started to invest heavily in the stock market, the results proved to be devastating, once the market started to crash. By 1932, 40% of all banks in the U.S. had gone out of business.

In total, 14 billion dollars of wealth were lost during the market crash.

Following the Crash:

  1. The Securities and Exchange Commission (SEC) was established;.
     
  2. The Glass-Stegall Act was passed. It separated commercial and investment banking activities. Over the past decade though, the Fed and banking regulators have softened some of the provisions of the Glass-Stegall Act;
     
  3. 3. In 1933, the Federal Deposit Insurance Corporation (FDIC) was established to insure individual bank accounts for up to $100,000.

The Crash of 1987

The markets hit a new high on August 25, 1987 when the Dow hit a record 2722.44 points. Then, the Dow started to head down. On October 19, 1987, the stock market crashed. The Dow dropped 508 points or 22.6% in a single trading day. This was a drop of 36.7% from its high on August 25, 1987.

Causes of the Crash:

  1. No Liquidity. During the crash, the markets were not able to handle the imbalance of sell orders;
     
  2. Overvalued Stocks;
     
  3. Program Trading and the Use of Derivative Securities Software. Large institutional investment companies used computers to execute large stock trades automatically when certain market conditions prevailed. Some analysts claim that the program trading of index futures and derivatives securities was also to blame.

During this crash, 1/2 trillion dollars of wealth were erased.

Following the Crash:

  1. Uniform Margin Requirements. New margin requirements were introduced to reduce the volatility for stocks, index futures, and stock options;
     
  2. New Computer Systems. Stock exchanges changed to new computer systems that increase data management effectiveness, accuracy, efficiency, and productivity;
     
  3. Circuit Breakers. The New York Stock Exchange and the Chicago Mercantile Exchange instituted a circuit breaker mechanism, which halts trading on both exchanges for one hour should the Dow fall more than 250 points in a day, and for two hours, should it fall more than 400 points.

The Crash of 2000

From 1992-2000, the markets and the economy experienced a period of record expansion. On September 1, 2000, the NASDAQ traded at 4234.33. From September 2000 to January 2, 2001, the NASDAQ dropped 45.9%. In October 2002, the NASDAQ dropped to as low as 1,108.49 – a 78.4% decline from its all-time high of 5,132.52, the level it had established in March 2000.

Causes of the Crash:

  1. Corporate Corruption. Many companies fraudulently inflated their profits and used accounting loopholes to hide debt. Corporate officers enjoyed outrageous stock options that diluted company stock;
     
  2. Overvalued Stocks. There were numerous examples of companies making significant operating losses with no hope of turning a profit for years to come, yet sporting a market capitalization of over a billion dollars;
     
  3. Daytraders and Momentum Investors. The advent of the Internet enabled online trading –a new, quick, and inexpensive way to trade the markets. This revolution led to millions of new investors and traders entering the markets with little or no experience;
     
  4. Conflict of Interest between Research Firm Analysts and Investment Bankers. It was common practice for the research arms of investment banks to issue favorable ratings on stocks for which their client companies sought to raise capital. In some cases, companies received highly favorable ratings, even though they were actually in serious financial trouble.

A total of 8 trillion dollars of wealth was lost in the crash of 2000.

Following the Crash:

  1. New Rules for Daytraders. Under the new rules that were introduced, investors need at least $25,000 in their account to actively trade the markets. In addition, new restrictions were also placed on the marketing methods daytrading firms are allowed to use;
     
  2. CEO and CFO Accountability. Under the new regulations, CEOs and CFOs are required to sign-off on their statements (balance sheets). In addition, fraud prosecution was stepped up, resulting in significantly higher penalties;
     
  3. Accounting Reforms. Reforms include better disclosure of corporate balance sheet information. Items such as stock options and offshore investments are to be disclosed so that investors may better judge if a company is actually profitable;4. Separation between Investment Banking and Brokerage Research. A major reform was introduced to avoid conflicts of interest in the financial services industry. A clear split between the research and investment banking arms of brokerage houses was mandated.
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Mutual Funds General

Mutual funds are most common type of investment in North America. With explosion of the number of mutual funds, funds investor in the 90s came a variety of specialty funds. Instead of using the capital to hire employees, purchase materials so on the investment fund purchase a diversified list of stocks, or bonds, or both for their income potential.

They have been complemented by funds specializing in

  • Certain industries;
  • Certain commodities;
  • Certain marketplace;
  • Developed exclusively to real estate investment or mortgages;
  • Futures on stock exchanges.

You can find funds for every objective, taste and interest. The number of funds is grooving daily.

The main characteristic of the mutual fund is that the price of the mutual fund’s shares has at all time define relationship to the net asset value of the mutual fund’s portfolio. The mutual fund continuously sells its treasury shares. The result is that the number of shares and investment capital are constantly changing.

A mutual fund has a simple capital structure. It has a nominal number of deferred shares (common shares), which are held by the sponsor of the company; and a number of shares, which are offered for sale to the public.

Mutual fund shares can be sold to the public by

  • Investment dealers and brokers;
  • Bank;
  • Trust companies.

There are usually five ways to buy mutual funds:

  • Cash investment – you can buy a number of mutual fund shares. Most funds offer a discount on the loading fee if the investment is usually more 25000$
  • Reinvestment of dividend – the shareholders can reinvest their dividend
  • Non-contractual saving plan – an investor can open a small account and then add monthly or quarterly amounts.
  • Contractual plan – specified amount each month over a specific period.
  • Withdrawal plan – one time investing in a fund and then withdraws dividends and some principal amount at regular intervals.

An investment fund does not guarantee a capital growth. The value of shares (units) is usually calculated by taking the total market value of all investments divided by number of units (shares). So, if a mutual fund succeeds on the market their shareholders are wealthy otherwise they can loose not only dividends but an invested capital as well.

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DJI Overview

Dow Jones Industrial Average History:

When Charles H. Dow first unveiled his industrial stock average on May 26, 1896, the stock market was not highly regarded. Prudent investors bought bonds, which paid predictable amounts of interest and were backed by real machinery, factory buildings and other hard assets.

Today, stocks are routinely considered as investment vehicles, even by conservative investors. The circle of investors has widened far beyond the Wall Street cliques of the past century to millions of everyday working men and women. These people are turning to stocks to help them amass capital for their children’s college tuition bills and their own retirements. Information to guide them in their investment decisions is abundantly available.

The Dow Jones Industrial Average Index played a role in bringing about this tremendous change. One hundred years ago, even people on Wall Street found it difficult to discern from the daily jumble of up-a-quarter and down-an-eighth whether stocks generally were rising, falling or treading water. Charles Dow devised his stock average to make sense out of this confusion. He began in 1884 with 11 stocks, most of them railroads, which were the first great national corporations. He compared his average to placing sticks in the beach sand to determine, wave after successive wave, whether the tide was coming in or going out. If the average’s peaks and troughs rose progressively higher, then a bull market prevailed; if the peaks and troughs dropped lower and lower, a bear market was on.

It seems simplistic nowadays with myriad market indicators, but late in the Nineteenth Century it was like turning on a powerful new beacon that cut through the fog. The average provided a convenient benchmark for comparing individual stocks to the course of the market, for comparing the market with other indicators of economic conditions, or simply for conversation at the corner of Wall and Broad Streets about the market’s direction.

The mechanics of the first stock averages were dictated by the necessity of computing it with paper and pencil: Add up the prices and divide by the number of stocks. This application of grade-school arithmetic, while creative is hardly worthy of remembrance more than a century later. But the very idea of using an index to differentiate the stock market’s long-term trends from short-term fluctuations deserves a salute. Without the means for the ordinary investor to follow the broad market, today’s age of financial democracy (in which millions of employees are actively directing the investment of their own future pension money and as a result are substantial corporate shareholders) would be unimaginable.

Following the introduction of the 12-stock industrial average in the spring of 1896, Mr. Dow, in the autumn of that year, dropped the last non-railroad stocks in his original index, making it the 20-stock railroad average. The utility average came along in 1929 (more than a quarter-century after Mr. Dow’s death at age 51 in 1902) and the railroad average was renamed the transportation average in 1970.

At first, the average was published irregularly, but daily publication in The Wall Street Journal began on Oct. 7, 1896. In 1916, the industrial average expanded to 20 stocks; the number was raised again, in 1928, to 30, where it remains. Also in 1928, the Journal editors began calculating the average with a special divisor other than the number of stocks, to avoid distortions when constituent companies split their shares or when one stock was substituted for another. Through habit, this index was still identified as an “average.”

The Dow Jones Industrial Average Today:

The 30 stocks now in the Dow Jones Industrial Average Index are all major factors in their industries, and their stocks are widely held by individuals and institutional investors. At the end of 1999, these 30 stocks accounted for about 28% of the $12 trillion-plus market value of all U.S. stocks.

Using such large, frequently traded stocks provides an important feature of the Industrial Average: timeliness. At any moment during the trading day, the Dow Jones Industrial Average is based on very recent transactions. This isn’t always true with indexes that contain less-frequently traded stocks.

The Dow Jones Industrial Average Index is the most-quoted market indicator in newspapers, on TV and on the Internet. Because of its longevity, it became the first to be quoted by other publications. This practice became habit when Wall Street earned at least a mention in the general news each day, and habit became tradition when the post-World War II bull market galvanized the nation’s attention. The Industrial Average became the indicator to cite if you were citing only one. Besides longevity, two other factors play a role in its widespread popularity: It is understandable to most people, and it reliably indicates the market’s basic trend.

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About DIA

DIAMONDS (Symbol: DIA)

DIAMONDS trade on the AMEX (AMEX: DIA). The DIAMONDS Trust Series I is a pooled investment designed to provide investment results that generally correspond to the price and yield performance, before fees and expenses, of the Dow Jones Industrial Average. There is no assurance that the price and yield performance of the Dow Jones Industrial Average can be fully matched. Quote for DIAMONDS: DIA

Trading DIAMONDS:

  • In January 1998, the AMEX launched DIAMONDS, a unit investment trust based on the Dow Jones Industrial Average. DIAMONDS allow investors to buy or sell shares in an entire portfolio of the Dow Jones Industrial Average stocks as easily as they do shares of a single stock.
     
  • Trading more than 1.7 million shares on its first day of listing, DIAMONDS enjoyed the most successful launch of any exchange product in AMEX history at that time.
     
  • A purchase of shares in this single investment vehicle gives the investor a participation in approx. 1/100th the value of the Dow Jones 30 Industrial Averages. When people are discussing “the market” they are usually referring to the 30 Industrials; the oldest index by far. Diamonds track the market. With the Dow at 10,000 the Diamonds sell at about $100 per share.
     
  • DIAMONDS are Exchange-traded securities that represent ownership in the DIAMONDS Trust, a long-term unit investment trust established to accumulate and hold a portfolio of the common stocks that comprise the Dow Jones Industrial Average.
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About SPDRS

SPDRs trade on the AMEX (AMEX: SPY).

The SPDR Trust Series is a pooled investment designed to provide investment results that generally correspond to the price and yield performance, before fees and expenses, of the S&P 500 Index. There is no assurance that the performance of the S&P 500 Index can be fully matched, but it does allow for more accurate market timing. Quote for SPDRs: SPY

Trading SPDRs:

  • SPDRs stand for Standard and Poor’s Depositary Receipts. Known as “Spiders,” a SPDR is a unit investment trust that holds shares of all of the companies in the Standard & Poor’s 500 Composite Stock Price Index (S&P 500). SPDRs closely track the price performance and dividend yield of the S&P 500. There are also SPDRs that represent other indexes or particular industry groups.
     
  • Investors who purchase a SPDR own approximately one tenth of the value of the S&P 500 and receive pro rata quarterly dividends less expenses of the trust. Unlike an index mutual fund that can only be bought and sold at the end of each trading day, SPDRs trade throughout the trading day.
     
  • SPDRs were first created back in January 1993 by a subsidiary of the American Stock Exchange. They trade on the Amex, and you can find them listed in quote servers under the symbol SPY. However, it’s pretty easy to figure out the price of a unit in the trust — it’s always the current value of the S&P 500 Index divided by 10. If the S&P 500 Index stands at 1097.31, the unit price of a SPDR is $109.73.
     
  • You can buy shares in SPDRs at any time when the market is open. (In comparison, you can only buy mutual fund shares at the end of the trading day.) Any brokerage firm will happily assist you in purchasing SPDRs for your portfolio, for a commission, of course.
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About SPDRS

The S&P 500 Composite Stock Price Index is a market-value-weighted index (shares outstanding multiplied by stock price) of 500 stocks that are traded on the New York Stock Exchange (NYSE), American Stock Exchange (AMEX), and the Nasdaq National Market System (NASDAQ). The weightings make each company’s influence on the Index’s performance directly proportional to that company’s market value. It is this characteristic that has made the S&P 500 Index the investment industry’s standard for measuring the performance of actual portfolios.

Unlike other lists of companies, the ones selected for the S&P 500 are not chosen because they are the largest companies in terms of market value, sales, or profits. Rather, the companies chosen for inclusion in the Index tend to be the leading companies in leading industries within the U.S. economy. That is why in 1968 the Index became a component of the U.S. Department of Commerce’s Index of Leading Economic Indicators. Now published by the Conference Board as the Composite Index of Leading Indicators, that widely followed index is used to signal potential turning points in the U.S. economy.

S&P 500 Index History

The origins of the S&P 500 Index go back to 1923, when Standard & Poor’s introduced a series of indexes that included 233 companies that were grouped into 26 industries. Since then, Standard & Poor’s has expanded its coverage over the years; in July 1996, following introduction of a new, comprehensive industry group classification system for all securities in the S&P Stock Guide Database, there were 105 specific industry groups in 11 economic sectors represented in the S&P 500. Four major industry sectors have also been developed: Industrials, Utilities, Financials, and Transportation. The number of companies in each major industry sector has been allowed to float since 1988 in order to enable the Standard & Poor’s Index Committee to react efficiently to an increasingly dynamic economy and stock market.

“Over the years, the S&P 500 has really become the index to beat for most investors,” according to Roger Fenningdorf, director of U.S. equity research at the Rogers Casey pension-fund consulting firm. “In the world of professional money management, we’ve all become fixated on how well managers do relative to the S&P.”

The use of the S&P 500 as the proxy for the overall stock market predates the widespread adoption of the Capital Asset Pricing Model (CAPM) in the 1970s. As the amount of money invested in the equity markets grew in the 1950s and 1960s, the need for a capitalization-weighted, broad-based market indicator that reflected how people actually invest in equities became self-evident. By convention, the S&P 500 Index, already well-known to academics and to professional money managers, was used as the market portfolio in tests of the CAPM. Betas of individual stocks were then calculated against the S&P 500 Index, which by definition had a portfolio beta of 1.00.

These days, it is difficult to find an equity manager who cannot tell you how its portfolio’s performance compares with the S&P 500. Some companies, such as Fidelity, even make a portion of their management fees contingent on whether their funds outperform the S&P 500. In the Magellan Fund’s case, its fee is raised or lowered by 0.20% of assets, depending upon how it fares against the S&P 500’s total return over a rolling three-year period.

However, it is no longer possible for an investment management firm simply to claim that it beat the S&P 500. The adoption of performance presentation standards by the Association for Investment Management and Research (AIMR) and their inclusion as of January 1, 1993, as Standard III F of the AIMR Standards of Professional Conduct, has focused attention on the need for properly defined and utilized investment benchmarks. The firm must use a benchmark that parallels the risk or investment style the client’s portfolio is expected to track.

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QQQQ Index Shares

Nasdaq 100 Index Shares (Symbol: QQQQ)

QQQQ trade on the NASDAQ (NASDAQ: QQQQ).
The Nasdaq 100 Shares (QQQQ), an index tracking stock – is the first financial product created by the new Nasdaq-Amex Market Group. Now for the first time, the stocks of the Nasdaq-100 Index are trading as one equity, opening the door to innovative and exciting investment opportunities. Quote for Qubes: QQQQ


Trading QQQQ:

  • With Nasdaq 100 index shares, you can buy or sell shares in the collective performance of the Nasdaq-100 Index in a single transaction – just as you buy or sell shares of individual stocks, but market timing becomes easier. It’s a one-investment portfolio that gives you ownership in the 100 stocks of the Nasdaq-100 Index.
  • Nasdaq-100 Shares trade like stock, you can buy them on margin, sell short or hold your shares for the long term.
  • The Trust is designed to closely track the price and yield performance of the Index – so you can expect your Nasdaq-100 Shares to move up or down in value when the Index moves up or down.
  • Even though they’ve only been around since March 1999, Qubes are so popular, their daily trading volume rivals the companies on the New York Stock Exchange. (Today, only three companies on the Big Board traded more briskly.)
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NASDAQ 100 Overview

The Nasdaq 100 Index includes 100 of the largest domestic and international non-financial companies listed on The Nasdaq Stock Market based on market capitalization. The Index reflects companies across major industry groups including computer hardware and software, telecommunications, retail/wholesale trade and biotechnology. It does not contain financial companies including investment companies.

Launched in January 1985, the Nasdaq 100 Index represents the largest non-financial domestic and international issues listed on The Nasdaq Stock Market based on market capitalization. The Nasdaq 100 Index is calculated under a modified capitalization-weighted methodology. The methodology is expected to retain in general the economic attributes of capitalization-weighting while providing enhanced diversification. To accomplish this, Nasdaq will review the composition of the Nasdaq 100 Index on a quarterly basis and adjust the weightings of Index components using a proprietary algorithm, if certain pre-established weight distribution requirements are not met.

The number of securities in the Nasdaq 100 Index makes it an effective vehicle for investors. In January 1994, options on the Nasdaq 100 Index began trading on the Chicago Board Options Exchange. The Chicago Mercantile Exchange began to trade futures and futures options on the Nasdaq 100 Index in April of 1996. Nasdaq 100 Index Tracking Stock (QQQQ) began trading on the American Stock Exchange in March 1999. In addition, the Index is used as a benchmark for financial products in many countries around the world.

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AMEX Stock Exchange Description

The alliance of technology and people is a hallmark of auction market trading, and the AMEX has been a pioneer in market innovation for nearly a century.

Today at the American Stock Exchange, specialists, traders and brokers use the world’s most sophisticated, advanced technology to enhance trading efficiency and reliability for the investing public.

AMEX technology improves customer service for all of the auction market participants each step of the way. For listed companies and their investors, our state-of-the-art trading ensures trading fairness. Member firms receive instantaneous order processing and reconciliation. Electronic display books greatly assist AMEX Specialists in maintaining efficient and liquid markets, resulting in narrower spreads for customers.

AMEX Stock Exchange Traded Funds (ETFs)

The American Stock Exchange’s Exchange Traded Funds (ETFs) Marketplace includes ETFs (Exchange Traded Funds) and iShares such as, DIA (Nasdaq-100 Index Tracking Stock, QUBES), DIA (DIAMONDS), and SPY (Select Sector SPDRs). Listed and traded in the Marketplace is an entire family of ETFs – index-based investment products that let you buy or sell shares of entire portfolios of stock in a single security. Pioneered by the Amex, these unique financial products combine the opportunities of indexing with the advantages of stock trading. With ETFs based on broad-market, sector and international indexes, you have a wide range of investment opportunities. You have the ability to establish long-term investments in the market performance of the leading companies in the leading industries in the United States, or you can custom tailor asset allocations using a range of ETFs (Exchange Traded Funds) to fit your particular investment needs or goals. You can hold ETFs based on a broad-market index as a core investment, for example, then use additional ETFs to increase your exposure in sector and/or international index performance.

AMEX Stock Exchange History

In 1995, the AMEX became the first U.S. stock market to maintain a presence on the world wide web, offering a site rich with comprehensive data on our listed companies, options, derivatives and capital markets products. We link, the exclusive, automated service for our listed companies, offers potential investors and shareholders a range of information on every AMEX stock.

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NYSE Stock Exchange Description

NYSE Stock Exchange History

The New York Stock Exchange traces its origins to a founding agreement in 1792. The NYSE registered as a national securities exchange with the U.S. Securities and Exchange Commission on October 1, 1934. The Governing Committee was the primary governing body until 1938, at which time The Exchange hired its first paid president and created a thirty-three member Board of Governors. The Board included Exchange members, non-member partners from both New York and out-of-town firms, as well as public representatives.

NYSE Stock Exchange Board of Directors

In 1971 The Exchange was incorporated as a not-for-profit corporation. In 1972 the members voted to replace the Board of Governors with a twenty-five member Board of Directors, comprised of a Chairman and CEO, twelve representatives of the public, and twelve representatives from the securities industry.

Subject to the approval of the Board, the Chairman may appoint a President, who would serve as a director. Additionally, at the Board’s discretion, they may elect an Executive Vice Chairman, who would also serve as a director.