What is 'Capitulation'
Capitulation is when investors give up any previous gains in stock price by selling equities, in an effort to get out of the market and into less risky investments. True capitulation involves extremely high volume and sharp declines, and is usually indicated by panic selling. The term is a derived from a military term which refers to surrender.
BREAKING DOWN 'Capitulation'
After capitulation selling, it is common to think that there are great bargains available. The belief is that everyone who wants to get out of a stock for any reason, including forced selling due to margin calls, has already sold. The price should then, theoretically, reverse or bounce off the lows. In other words, some investors believe that true capitulation is the sign of a bottom.
Capitulations can only be identified after they have formed, in hindsight. While investors and traders alike often attempt to anticipate capitulation in selling or buying, the reality is that capitulations are outcomes that result from the maximum psychological and financial pain that can be endured by a group before throwing in the towel.
Technical Analysis of Capitulations
Capitulations often signal major turning points in the price action of underlying securities and financial instruments. Technical analysts can visually identify capitulation with candlestick charts. The hammer candle forms at the end of a selling frenzy when the lowest price is made, as capitulation sets in and signals a price bottom followed by a reversal bounce. In essence, anyone who has wanted to sell their position has done so as the fear reached the turning point. The fear then starts to subside, and greed may set back in again as the price starts to rebound, taking the price higher.
On the opposite spectrum, a shooting star candle forms at the end of a buying frenzy, when the highest price is reached and capitulation forms, indicating a top followed by a reversal sell-off. Anyone who has wanted to buy a position has done so as the greed reached the turning point. The greed of attaining a position at any cost quickly starts to subside when the price starts to fall quickly. When the last batch of buyers see their position falling into the red, fear starts to creep into the psyche. As the price falls lower and lower, it peels off waves of earlier buyers who start to sell their positions to salvage remaining profits or limit the extent of losses.
The extent of capitulation can be measured on different charting time frames, as small as a one-minute chart or as large as a weekly or monthly chart. The rule of thumb is that the larger the time frame, the more powerful the capitulation. This is because it allows for more participants to engage and determine the outcome.