What Is Capitulation?
What is Capitulation?
Capitulation is when investors give up any previous gains in any security or market by selling their positions during periods of declines. Capitulation can happen at any time, but typically happens during high volume trading and extended declines for securities. A market correction or bear market often leads investors to capitulate or panic sell. The term is a derived from a military term which refers to surrender.
After capitulation selling, many traders think there are bargain buying opportunities. The belief is that everyone who wants to sell 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 capitulation is the sign of a bottom.
Investors can only identify capitulations after they have occurred. While traders often attempt to anticipate capitulation selling or buying, the reality is that capitulations are outcomes that result from the maximum psychological and financial pain that can be endured by investors before liquidating their positions. (To learn more, see: Profiting From Panic Selling.)
Using Technical Analysis to Identify Capitulations
Capitulations often signal major turning points in the price action of underlying securities and financial instruments. Technical analysts can visually identify capitulation using candlestick charts. Hammer candles often form 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 on heavy volume. Traders who wanted to sell their positions have done so as panic reached a climax. As fear starts to subside, greed may set in and reverse prices.
Conversely, a shooting star candle often forms at the end of a buying frenzy, when prices reach their high, indicating a top is in place. Traders who wanted to buy a position have done so, and the fear of missing out has reached an extreme. The greed of attaining a position at any cost starts to subside when prices fall rapidly. When the last group of buyers sees their positions declining, fear starts to creep into the market. As prices continue to fall, buyers who purchased earlier start to sell their positions to salvage remaining profits or limit losses. (For further reading, see: Market Reversals and How to Spot Them.)
The extent of capitulation can be measured on different charting time frames as small as a one-minute chart, or as large as a monthly chart. Larger timeframes typically produce more reliable capitulation signals as they allow participants to engage and determine the outcome of price action.