What Caused the Market to Drop over 1000 Points at the Open Today?

You don't want to see this happen the market.

The stock market was in free fall today.
Watch out, falling markets.

Some days the stock market is so bad it's not even worth getting out of bed.  Especially when you haven't even been to bed.

What most people don't know is that on Sunday afternoon, at 5:00 pm EST, the stock market futures open.  These futures track various commodities as well as the three major indexes - The Dow Jones Industrial Averages, The S&P 500, and The NASDAQ.  And all night long Sunday night, and early into Monday morning, I watched as they all ran red.

Then as we got closer to the 9:30 pm EST market open, things accelerated down, hard.  Very hard. For one brief, terrifying moment right at the open, the Dow Jones Futures were down 1400 points. Take a look at that for a moment.

-1400

That is crazy.  I have been in the markets for almost 30 years, and I have seen a lot of stuff...

The 1987 crash, where the market lost 23% in one day.  The Dot-Com bubble and implosion.  The Financial Crisis.  And the Flash Crash. But out of all those things, I have never seen a scarier open than what we got on August 24th, 2015.

So the question you are probably asking is, "why did the markets plunge so hard and so fast?."

If you listen to the financial pundits on TV, they will tell you that it was everything from China, to Greece, to The Fed talking about raising rates, or possibly an evil wizard somewhere who once lost all his money in the market casting a spell.

But it was none of those reasons.  It was simple mechanics.

To understand this phenomenon, you have to look at what happened at the end of last week.  The market sold off hard and fast for three days straight, stopping right at a crucial support level from last October.

At that level there were a lot of scared bulls and a lot of giddy bears.

 And the problem was, since the market moved down so fast, there were a lot of people - both individual investors and institutional investors - who ran the risk of a margin call if the market opened down Monday morning.

A margin call is a simple product of math.  You don't have enough cash in your account to cover your leveraged margin positions, and you broker or clearing firm forces you to come up with more cash.  And the way most people do that is to sell the existing securities they have in their account.

This forced selling exasperates the downward motion of the markets, and the farther they fall, the more people who get caught up in their own margin calls.  It becomes a vicious circle until all the sellers are washed out.  That is why you had the tremendous flush at the open, then once the sellers were gone, buyers came back in a bid the market back up.

The scary thing about the mechanics of the market taking over is that no type of methodology can stand up to it.  Not technical, not fundamental.  Instead, it is best to just stand aside, be all in cash, and wait for the dust to settle.

Photo Credits: Steve Fitchett /Photographer's Choice/Getty Images