Tail Risks, Margin Call: A 1987 crash example

Sometimes we think we know things but turns out what we think we know, but in truth we didn’t know that really bites us. Goh Eng Yeow provides a timely example in the Sunday Times:

I find myself repeating this advice to younger investors who have the wrong impression that they can take big risks because they have youth on their side and time to make good any losses they may incur. But I know from experience how difficult it is to cut losses on a bad investment. The pain of a loss is always hard to bear.

Some people never recover from the blow.

Early in my working life, there was a major stock market crash in October 1987 – known in financial history as Black Monday – with Wall Street plunging by an eye-popping 23 per cent in a single day.

A good friend of mine had just started working in Hong Kong and he liked to place an occasional bet in the Hong Kong futures market. He would make a 5 per cent downpayment for a futures contract on the Hang Seng Index and hope to sell it for a profit before taking delivery of the contract.

Then New York crashed and the Hong Kong market was forced to close for four days as it waited for the storm to abate. When it finally re-opened, the Hang Seng Index plunged 33 per cent.

My friend’s downpayment was not sufficient to cover the huge loss sustained on his contract and he was asked to make good the difference – a cool HK$1 million (S$220,000 at that time). He could not pay up, he was made a bankrupt and his girlfriend left him soon after.

My friend’s experience flags the peril an investor may encounter during a market calamity, even though he might be taking what he believed to be an acceptable risk on his investment.

Two past articles on risk management:

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Kyith

Kyith is the Owner and Sole Writer behind Investment Moats. Readers tune in to Investment Moats to learn and build stronger, firmer wealth foundations, how to have a Passive investment strategy, know more about investing in REITs and the nuts and bolts of Active Investing.

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