A:

By definition, capitulation means to surrender or give up. In financial circles, this term is used to indicate the point in time when investors have decided to give up on trying to recapture lost gains as a result of falling stock prices. Suppose a stock you own has dropped by 10%. There are two options that can be taken: you can wait it out and hope the stock begins to appreciate, or you can realize the loss by selling the stock. If the majority of investors decides to wait it out, then stock price will likely remain relatively stable. However, if the majority of investors decides to capitulate and give up on the stock, then there will be a sharp decline in its price. When this occurrence is significant across the entire market, it is known as market capitulation.

The significance of capitulation lies in its implications. Many market professionals consider it to be a sign of a bottom in prices and consequently a good time to buy stocks. This is because basic economic factors dictate that large sell volumes will drive prices down, while large buy volumes will drive prices up. Since almost everyone who wanted (or felt forced) to sell stock has already done so, only buyers are left - and they are expected to drive the prices up. (If you are unfamiliar with these principles, check out our Economics Basics Tutorial.)

The problem with capitulation is that it is very difficult to forecast and identify. There is no magical price at which capitulation takes place. Often, investors will only agree in hindsight as to when the market actually capitulated.

For more on this topic, check out the article Capitulation Defined.

RELATED FAQS

  1. Why are economists interested in the consumer surplus?

    Understand why an economist would be interested in consumer surplus. Learn why an economy would want to maximize consumer ...
  2. What does it mean to be long or short a derivative?

    Find out more about derivative securities and what it indicates when traders or investors establish a long or short position ...
  3. What is an over-the-counter derivative?

    Learn more about over-the-counter derivatives and how they work with an example of a derivative trade-off exchange.
  4. What does the underlying of a derivative refer to?

    Find out more about derivative securities, what an underlying asset is and what the underlying assets refer to in stock options ...
RELATED TERMS
  1. Factor Market

    A marketplace for the services of a factor of production.
  2. Tactical Trading

    A style of investing for the relatively short term based on anticipated ...
  3. Maximum Drawdown (MDD)

    The maximum loss from a peak to a trough of a portfolio, before ...
  4. Gross Exposure

    The absolute level of a fund's investments.
  5. Exchange Traded Derivative

    A financial instrument whose value is based on the value of another ...
  6. Catastrophe Equity Put (CatEPut)

    Catastrophe equity puts are used to ensure that insurance companies ...

You May Also Like

Related Articles
  1. Economics

    Venezuela: Portrait of a Country in ...

  2. Economics

    How the UK Makes Money

  3. Options & Futures

    Why Is Best Buy Stock So Volatile?

  4. Trading Strategies

    A Guide Of Option Trading Strategies ...

  5. Options & Futures

    Options and Roth IRAs: Do's and Don'ts

Trading Center