Stealth Capitulation Draws Nigh

Capitulation is one of the most misunderstood and badly abused concepts in the stock markets. The word is thrown around with abandon and often just out of hope when the action is particularly miserable.

The concept is the cornerstone of contrarian thinking and is an easy one to grasp. Capitulation occurs when emotions become so extreme that people can't stand to hold on to losing stocks any longer and they want out at just about any price. This is an indication that a bottom is near, because everyone who is inclined to sell has already done so, and there is little selling pressure left.

Capitulation is most often thought of occurring in the form of a big whoosh down where there is a substantial point loss and then a quick snap back up as new buyers replace the capitulating sellers.

The crash in 1987 is probably the best example of capitulation. The market was downtrending rather sharply for a couple weeks. The DJIA had already fallen from over 2600 to around 2200 when on Oct. 19, it crashed 508 points and closed at 1738. The next day the market bounced back 102 points and the following day another 187 points. The market continued in a trading range with a fair amount of volatility for many months afterward, but the bottom was in after the panic-selling of Oct. 19.

A crash like the one in 1987 is very rare. Much more frequently, capitulation occurs with a whimper of pain, not a crescendo of agony. The market is much more painful and cruel when it drips slowly lower over the course of many weeks. Those who are hoping and praying for a reversal are disappointed again and again and the primary emotion is disgust. When no one can stand this slow painful process for another day, we bottom with a whimper and then slowly start to recover.

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James "Rev Shark" De Porre is a self-taught trader who primarily trades for his own account from his home on Anna Maria Island, Fla. He is a member of the Michigan Bar Association and a former tax attorney and CPA. De Porre holds business and law degrees from the University of Michigan. He was formerly the host of America Online's The Shark Attack and presently operates SuperTraders.com. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Rev Shark appreciates your feedback; click here to send him an email.