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Definition of 'Capitulation'

Capitulation is the kind of panic selling that builds momentum, causing a dramatic decline in stock prices and dropping them to a "bottom." This floor is often near or below previous support levels. A bottom is a mythical place where almost everything looks cheap enough to buy. The bottom, by definition, marks a turn in the market, and is followed by a broad, sustained rally. During a "capitulative" selling period, market watchers talk incessantly about whether there is enough fear in the market. The more fear there is, the more it looks like the market will hit a bottom.

Fear is measured by gargantuan volume, a high ratio of put-to-call options buying and extreme volatility. People buy put options when they're betting stocks will go down and call options when betting stocks will go up. A put-to-call ratio anywhere over 1 is considered a sign of fear and panic. Sharp spikes in the Chicago Board Options Exchange Volatility Index, commonly called the VIX, are indications of high volatility. The volatility index is a measure of how much people think the S&P 100 index of large companies will fluctuate over the next year.

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