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Rupert Hargreaves
Rupert Hargreaves
Articles (685)  | Author's Website |

How Warren Buffett Acts in a Flash Crash

Buffett's advice to investors following the 1987 flash crash

February 07, 2018

At the beginning of this week, the Dow Jones Industrial Average dropped around 1,175 points in a single day- its largest fall in intraday trading ever.

While this was the index's most substantial drop in terms of points, it was not the largest drop in percentage terms. In fact, it did not come anywhere close. The crash of 1987 still holds the record for the most significant drop in percentage terms, when the index lost around 22% in one day.

Considering this fact, I thought it would be interesting to go back and see what Warren Buffett (Trades, Portfolio), the "Oracle of Omaha," was saying to his shareholders in 1987 when the world was gripped with one of the most significant stock market crashes of all time.

Letter to investors

As you would expect, Buffett did not devote much of his 1987 letter to the crash. He has never been one for speculating on short-term market movements or worrying about what the market is doing over the span of just one year. He is possibly the best-known, long-term investor in the world, and that's exactly what his letter told readers:

"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 parallels between the market environment Buffett is describing above and the one we currently find ourselves in. Today's volatile markets are a result of overleveraged volatility traders, high-frequency trading and algorithm-driven investment strategies (in the most simple form). These big players dominate with tens of billions of dollars in capital moving the market, but does this mean the average investor has now been crowded out? No, it is the exact opposite. As Buffett described in 1987:

"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 stick to your investment strategy, the big boys should not be able to push the little investors around. That being said, there is one person Buffett cautions investors should be aware of at all times: Mr. Market.

"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.'"

So it is easy to sum up Buffett's advice for turbulent market environments. No matter how pushed about you feel by the rest of the market, if you want to make a successful career out of investing, you need to ignore all of the market participants. Mr. Market is there to serve you and not to guide you, so letting him force your hand is probably one of the biggest mistakes you can make in investing. The best guarantee against letting this happen is to know your investments inside out and have enough knowledge to be sure you have made the right decision, even if the stock drops 50%.

About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website

Rating: 5.0/5 (4 votes)



Heidis - 11 months ago    Report SPAM

Rupert Hargreaves, you are a blessing. I’ve been learning/studying investing for over a year, and your articles are so clear and helpful. Cheers

Jtdaniel premium member - 11 months ago

Hi Rupert,

Great article. I found opportunity early this week to add to three of my favorite holdings -- Hormel, Exxon-Mobil and Wells Fargo. These are stocks I intend to hold for the duration. so an occasional price drop can turn out to be a positive development. Best, dj

Georgedona - 11 months ago    Report SPAM

"Widespread fear is your friend. As an investor, you should love it when virtually all stocks are falling, as this is the time to look for bargains" Warren Buffet.

Rupert Hargreaves
Rupert Hargreaves - 11 months ago    Report SPAM

@Heidis, I'm glad you think so. Hopefully, I will continue to produce content that's useful to you.

@dj, agreed. The best stock to buy is often the one you already own.

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