What Is Capitulation

What Is Capitulation in Stocks?

Historically, to capitulate means to “surrender.” As far as the market is concerned, capitulation is the fancy word for panic selling. What comes to mind are images of people running around like chickens with their heads cut off, selling everything for fear of additional losses. Historically, to capitulate means to “surrender.” As far as the market is concerned, capitulation is the fancy word for panic selling. 

What comes to mind are images of people running around like chickens with their heads cut off, selling everything for fear of additional losses. Unfortunately, yet predictably, it has become a market-wide phenomenon affecting most stocks. This erratic behavior is most often seen during bear markets and corrections. During this time, the market begins its downward spiral. 

  • Capitulation means to surrender or give up
  • Market capitulation happens when panic selling becomes a market-wide phenomenon
  • There is no widely accepted measure of capitulation
What Is Capitulation Example?

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Selling Off Stocks

This is how it usually goes down; you’re watching the market and noticing a gradual decline in stock prices. As sharper declines begin, investors move their money into stable investments like preferred stock, precious metals, corporate bonds, or government bonds. 

However, moves like this, especially large sell off’s, can and do spark fear in other investors. And the domino sell-off begins. Although rare, a market-wide recession can occur as the fear of unrealized capital loss overrides rational thought.

As you know, in dominos, as one falls, the rest goes. Similarly, one seller leads to two sellers, then thousands. So fear is rampant, the sell-off begins, and we have rapid price drops. 

What Does Capitulation Look Like?

So what does how does the start of the capitulation look like? First, companies sometimes start laying off workers, and speculative-level companies go bust. 

Just this past May, the crypto world witnessed one of its biggest crashes. In just a matter of days, LUNA, the Terra native token, crashed to almost zero. The crash was huge and wiped out more than $40 Billion of investors’ wealth in a matter of days.

In addition, the significantly increased supply of LUNA on crypto markets and the de-pegging of UST caused investors to lose faith in the project. As a result, the price of LUNA crashed until it was worthless. 

How to Identify Capitulation in a Stock

We can often identify capitulation by two trends:

  1.  Heavy selling volume 
  2.  A sharp drop in price after a long period of a stock price decline. 

Just take a look at the example below from Alibaba Group Holdings Limited:

What Is Capitulation

The chart above shows the capitulation of investors/traders in Alibaba Group Holdings Limited. Following a multi-month stock price decline, capitulation likely occurred in November 2021, resulting in the stock price of Alibaba dropping from $167 to a low of $109, a decline of 35% within two weeks.

Why is capitulation difficult to predict? 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 capitulated. 

What Causes Capitulation?

Many things: bad news coming out, war, pandemics, scandals, the list goes on and on. 

Macroeconomic Events

Sometimes, capitulation in the stock market happens in response to a particular macroeconomic event. Look no further than the 2008 housing bubble burst and subsequent banking crisis. This led to market-wide panic selling that turned into a serious recession. 

More recently, we saw a cascade of capitulation during the early stages of the COVID-19 pandemic. It lasted until mid to late March, so in that case, the process took about a month. Even though it was less serious and shorter-lived than the 2008 capitulation, the stock market took a nose dive. 

Disappointing News

No surprise here. Any time a company misses earnings estimates drops sales numbers or has uncertainty in leadership, capitulation can be activated. 

Unfortunately, yet predictably, it will become a market-wide phenomenon affecting most stocks. 

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Have Markets Seen Full Capitulation?

Markets, when they turn, they turn quickly, and they turn predictively. On Tuesday, Bank of America’s July global fund manager survey showed that full capitulation had been reached after investor allocation to stocks plunged to the lowest since October 2008, while exposure to risk assets dropped to levels not seen even during the global financial crisis.

Scott Clemons of Brown Brothers Harriman says he’s skeptical that markets have hit bottom. He’s on “Bloomberg Surveillance.” (Source: Bloomberg)

How long does capitulation last? This is likely not what you want to hear, but there are no set rules on how long capitulation can last. Also, when looking back, investors can’t even agree on when it began or ended. 

I’d be skeptical if any financial advisor or fund manager asked me to buy the dip. Stop buying the dip in a bear market. At this time, I’m stockpiling my cash for the big drop and investing when the time is right. 

Final Thoughts: What Is Capitulation?

Buy stock in several companies that make products & services that you believe in. Only sell if you think their products & services are trending worse. Then, don’t panic when the market does. This will serve you well in the long term.

A positive global event must happen before we see a healthy market again. This is a fantastic opportunity for those who can maneuver this environment well, like in 2008/2009.

Every situation is different, however, and single-stock panic selling can occur much more quickly than market-wide capitulation. Hindsight is always 20/20, and it’s no different for capitulation. We all want to buy at the bottom just before the stock rebounds, but good luck. Be careful of bull traps in a bear market; there are about 3 or 4 traps historically before the bottom. While markets have recently rallied from their lows, it is too soon to say that the moment of capitulation is already behind us.

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