For example, you may note a significant price decline and increased trading volume. It is hard to tell if there will be a drop after capitulation until you see a price rebound. This rebound happens when sellers and buyers who do not fear such risks view capitulation as an opportunity.
However, there is no guarantee that the ones who buy at such a time will not sell at a lower price and increase the price drop.
What Is Market Capitulation?
It is the point when the market is at its lowest, a situation that happens more in a bearish market. At such times, investors can sell investments to reduce losses or hold and wait for the price decline to pass.
Therefore, it comes with widespread pressure on investors to sell capitulation stock. This dramatic downturn in capitulation stock market prices can also come from negative headlines or revenue reports.
When investors feel they cannot take the losses any longer, they sell and exit. During that time, when the trading volume increases as the price decreases, only risk-takers remain in the market.
Such investors use the buy-the-dip strategy for capitulation trading when the price is low, hoping to profit later. But this comes after technical and fundamental analysis to find the best time. Some use charts to look for hammer candlestick patterns seen after a price decline.
What Is Its Significance?
Capitulation has much to do with investor behavior, as the people who bow to the selling pressure are more than the investors who do not overreact. Hence, trading capitulation causes widespread panic among investors. Due to that, it may take a long time for the market to bounce back from such low stock prices.
Such market crashes may influence future decisions by investors. They may become more cautious, preferring to buy stocks with a higher price.
Also, they may wait until negative sentiments diminish before entering the market. The specific stocks that crash may have less demand. However, the company can survive such repercussions if it has strong fundamentals.
Another significant effect is the type of stocks investors buy in the future. Therefore, some will shy away from the ones with volatile prices. As such, they may buy bonds, currency, and commodities because they feel equity is risky.
It might be necessary for an investor to know about capitulation, so they can analyze their risk tolerance. That helps them use strategies like portfolio diversification to lower the risk.
How can you tell if a market has capitulated?
The market lacks a specific method of measuring capitulation in trading. Therefore, the best way to tell when the market is about to hit its bottom is through indicators. There are many indicators, from technical ones like market volume and momentum to economic indicators.
One of the ways traders tell there is capitulation in trading is an increase in trading volume accompanied by a price decline. However, in most cases, trading capitulation is something you identify in the future, in hindsight, after the market rebounds. So, you can look for other signs, such as seeing many institutional investors exit.
What’s an example of market capitulation?
Let us say stock prices fall significantly despite bullish sentiments that the price will bounce back. Then, the same price drops again, and investors begin to panic. Hence, many of them sell and exit. This action triggers a similar move by other investors, and the price drops further.
A few investors hang on, some opting to buy the dip. Others among them are bullish, hoping the price will bounce back. A real-world example of such a situation happened to S&P 500 index in March 2020. It experienced a crash where the price fell by 5% intraday and closed with a 2.9% loss. The following week, it gained by 17%.