Stock Market Capitulation
In finance, capitulation is panic selling, or liquidating a position in a security at a loss as that security declines in price over fears of additional losses.
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What Is Capitulation in Stocks?
The Merriam-Webster dictionary defines capitulation as, "the act of surrendering or yielding." In the financial world, capitulation means giving up on a security or even an entire market following a period of price declines, and selling, or liquidating a position, at a loss. Investors capitulate when they fear they could suffer even worse losses in the near future.
Investors who hold onto a security despite the investment losing value are said to have "diamond hands". Investors who sell investments too early because they are risk averse are said to have "paper hands".
Capitulation happens at any of these "points":
- A price point: the price at which an investor decides to stop their bleeding and before the security's price falls even further
- A point in time: the time when investors give up holding a security in the hope of its price rising
- A psychological point: the moment when an investor accepts that they have lost money on a security.
What Causes Market Capitulation?
Capitulation follows downtrends in markets, which happen when more investors sell than buy. This activity is generally a response to:
- FUD, or fear, uncertainty, doubt
- A bear market
- Poor earnings results
- Negative company news
- Negative macroeconomic trends
What Happens to the Price of a Capitulating Stock?
If multiple investors capitulate at the same time, the price of a security or an entire market will drop sharply because large sell volumes drive prices lower. When capitulation occurs market-wide, it is called a market capitulation.
Signs of Stock Capitulation
Market professionals consider the capitulation phase as reflecting the bottom of a security's or a market's price, and if investors could identify when capitulation takes place, it would signal the ideal time to buy. This is because everyone who wanted to sell the security has already done so, and only buyers are left.
The problem in identifying capitulation is that it is usually only visible in hindsight rather than in foresight, however, there are a few indicators that may signal that capitulation is happening:
- When the price of a security has been in decline for a while and trading volumes are high
- When market prices fall by 10% or more
- A hammer candlestick appears in a security's Japanese candlestick chart
Identifying Capitulation with Stock Charts
Japanese candlestick chart (Ihor Reshetniak/iStockPhoto)
For a security, each individual candle in a Japanese candlestick chart displays four vital pieces of information, including the following prices achieved over the course of a day:
- Open
- Close
- High
- Low
The x-axis of a Japanese candlestick chart displays time, and the y-axis displays price.
The body of a candle displays the security's opening and closing prices so that long candles reflect a large difference between the opening and closing prices. An open or green-colored candlestick indicates that the security closed at a higher price than it opened, and in that case, the closing price appears at the top of the candle and the opening price appears at its bottom.
If a security closed at a lower price than it opened, then the candle is either solid or red, and the closing price appears at the bottom and the opening price appears at the top.
Just like real candles, the candles in Japanese candlestick charts have "wicks" both at the top and bottom. The top wick displays the highest price achieved by the security over the course of a day, and the bottom wick displays the lowest price achieved. A candlestick without either a top or a bottom wick indicates that the opening or closing price was also either the high or low price. The longer the wicks, the greater the price volatility of the security.
Capitulation is sometimes indicated by the presence of a Hammer candle:
Hammer candle (Wendorf)
Hammer candles signal that sellers have capitulated, and the market is trying to find a bottom. Hammers have a small body, meaning that the opening and closing prices are similar, and they have a lower wick that is at least twice as long as the height of the body.
Capitulation is most apparent when hammer candles are preceded by at least three declining candles, which are candles where each closes lower than the close of the candle preceding it, and when the candle following the hammer candle closes above the closing price of the hammer candle.
Capitulation Phase in Crypto/Bitcoin
1-year Bitcoin price chart (SeekingAlpha)
Capitulation that occurs in cryptocurrency markets is often stronger than in traditional markets. For example, Bitcoin had a precipitous drop starting on May 2, 2021 when it dropped from $57,374.33 to $29,795.55 by July 17, 2021. This 40% drop was attributed to negative news coming out of China about Bitcoin mining. Capitulation will be more severe in speculative assets.
How Long Does a Capitulation Phase Last?
The duration of a capitulation can last between one minute and a month. A longer duration provides more reliable data which can be seen on a Japanese candlestick chart. Analyzing this data allows analysts and investors to spot trends in price movement.
Bottom Line
Being able to spot capitulation can help identify the possible bottom of the price of a stock or the market as a whole. Following on the heels of capitulation can be a significant bargain buying opportunity.
FAQ
A "flush" will often happen when a stock has bottomed for the day, and it also happens when the S&P 500 Index has hit a low for the day. A flush can be seen on a Japanese candlestick chart when a long lower wick forms due to the security or market dropping by a large amount, and it signifies a sell-off.
Capitulation can be either bullish or bearish. In bullish capitulation, investors realize they have made a mistake by selling a security or leaving the market and they re-buy the security or they re-enter the market.
In bearish capitulation, investors may have given up entirely on a security, or the market as a whole.
This article was written by
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