What is Capitulation ?
Capitulation refers to a situation where investors give up hope and sell off their investments at any price just to get out of the market. It often happens during a prolonged downturn or a financial crisis when investors are feeling overwhelmed by losses and fear further declines.
Suppose a stock you own dropped by 30% but you were sure it would bounce back. Imagine it then fell another 20% but it was clear the fundamentals were solid. Maybe you bought a little more on the dip. Now imagine the same stock is down 15% intraday and the grind of daily disappointment has given way to certain knowledge that you bought a loser that could go even lower. Selling the stock as a result would be an act of capitulation.
Using Technical Analysis to Identify Capitulations :
Capitulations often signal major turning points in the price action of underlying securities and financial instruments. Technical analysts use candlestick charts to identify capitulation patterns. One such pattern is the hammer candle or shooting star which marks a trading session in which the price drops well below its opening level but reverses to regain much of the loss by the close. When accompanied by heavy volume, it suggests the decline reached a climax.
An interesting example of capitulation occurred with the price of Tesla (TSLA) after reaching its all-time high of $414 on Oct. 31, 2021. Over the next fifteen months, the stock alternated between sharp drops and brief rebounds. By the opening of 2023, TSLA had reached a low of $101, a loss of more than three quarters.
However, the stock rebounded just as quickly, reaching $208 over the next six weeks, with daily volume at one point exceeding $1 billion. In retrospect, the final price drop represented a period of capitulation, as speculators accepted their losses and new investors assumed their positions.
How Do Traders Identify Capitulation?
Traders and analysts may observe a variety of sentiment and technical indicators, such as the relative strength index, fibonacci ratios, candlestick patterns, and the moving average convergence-divergence, to determine when the buy or sell pressure for a certain asset is close to exhaustion. However, none of these methods is faultless, and the only 100% accurate way to identify capitulation is in hindsight.
Is Capitulation Good or Bad?
Capitulation is neither good nor bad, but it can be profitable depending on an investor's position. Investors with a long position stand to profit during a bullish capitulation as short sellers close out their positions. During a bearish capitulation, speculators may have the chance to snatch up shares at a discount as other traders abandon their positions.