What Does Capitulation Mean in Simple Terms?
Traditionally, capitulate means “surrender.” When applied to investing, it refers to selling a stock for a loss—usually during a phase of extended decline. In other words, when an investor capitulates, they “surrender” by choosing to realize a previously unrealized capital loss by selling a stock rather than continuing to hold onto it due to fear of additional loss.
Capitulation is somewhat self-reinforcing and can cause a cascade during which the price of a stock falls sharply over a very short time. If a stock’s price has been in a gradual decline for, say, five months, then a disappointing earnings forecast or some other negative news causes a noticeable selloff that drops the stock’s price a few percentage points in a day, this can cause additional investors to sell, pushing a stock’s price even lower. This cascading effect can cause a stock’s price to crash through previously established support levels, making its new floor price unclear.
Once all of a stock’s panic sellers have capitulated (i.e., when the stock’s price stops falling sharply and begins to stabilize), investors who are still bullish on the stock may think it has hit a new bottom and may see this as a buying opportunity, hoping the stock will rebound and begin to appreciate.
This is based on the assumption that all of those who were going to sell have sold, so only buyers remain, and they will push the stock's price up. However, identifying the “end” of a period of capitulation is hard to do until it has already happened.
What Is Market Capitulation?
Market capitulation occurs when panic selling becomes a market-wide phenomenon that affects most stocks. This most often occurs during bear markets and corrections when most of the market begins to lose value.
If most stocks have been in a gradual decline, then sharper declines begin to occur, investors may begin to sell off their stocks and move their remaining money into more stable investment vehicles like preferred stock, precious metals, corporate bonds, or government bonds.
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This can cause more rapid price drops, which can inspire fear in additional investors, causing additional selling, and so on. When the psychological effects of unrealized capital loss become strong enough and prevalent enough, a market-wide recession may even occur, although this is rare.
What Causes Capitulation?
Market-wide capitulation can sometimes happen in response to a particular macroeconomic event. The bursting of the housing bubble and subsequent banking crisis in 2008 led to market-wide panic selling that turned into a serious recession. The onset of the COVID-19 pandemic in early 2020 also set off a cascade of capitulation, although it was less serious and shorter-lived than the selloff of the late 2000s.
When it comes to a particular stock rather than the market at large, capitulation can occur as a result of disappointing news (e.g., dropping sales or missed earnings estimates) being released during an existing period of decline, assuming the stock’s resulting price drop is substantial enough to frighten a significant number of investors into selling.
How to Spot Capitulation in a Stock
Capitulation is much easier to identify in hindsight than in real-time, but investors who want to buy in at a stock’s bottom often try to identify the end of a period of capitulation so they can buy a stock just before it rebounds. One way traders attempt to do this is by analyzing a stock’s candlestick chart to see if they can identify a “hammer candlestick” following a period of decline.
What Is a Hammer Candlestick?
Each candlestick on a candlestick chart shows a stock’s open, close, high, and low prices over a particular period. A hammer candlestick is one in which the open and close are close to one another (indicated by a short thick), the top shadow is short, and the bottom shadow is very long, indicating that a stock traded very low during much of the period in question before rallying and closing very close to (above or below) its open price.
Historically, hammer candlesticks are often present at a stock’s bottom at the end of a period of decline and capitulation and just before a rebound in price. That being said, this isn’t always the case, and past trends do not guarantee future results. Attempting to identify a stock’s post-capitulation bottom using candlestick charts—like any other investing strategy—involves risk.
How Long Does Capitulation Usually Last?
There is no set rule as to how long capitulation can last, and even in retrospect, different investors may have different opinions as to when a certain period of capitulation began or ended, exactly.
The period of market capitulation that followed the onset of the COVID-19 pandemic appears to have begun around mid to late February 2020 and lasted until mid to late March, so in that case, the process took about a month. Every situation is different, however, and single-stock panic selling can occur much more quickly than market-wide capitulation.