Capitulation

Written By:
Paul Tracy
Updated September 30, 2020

What is Capitulation?

Capitulation occurs when investors attempt to exit an investment or market so quickly that they are willing to surrender any and all gains to do so. Panicked behavior often causes a capitulation, and investors may attempt to liquidate most or all of their holdings in these circumstances.

How Does Capitulation Work?

A capitulation frequently occurs after a security or a market has endured a long, downward slide in value; it is the final act of hitting bottom. There are four general signs a capitulation is occurring or has occurred.

Significant Changes in Trading Activity
Capitulations commonly involve unusually high trading volumes and price declines, typically over one or two trading days (although they can last longer).

High Levels of Cash Held by Mutual Funds
The presence of large numbers of investors attempting to exit the market by selling their Mutual Fund shares frequently compels mutual funds to hold high levels of cash in order to meet those demands.

Unusually High Derivatives Activity
Large increases in put purchases or option volatility indexes indicate that investors are either strongly betting against a market increase or are rapidly attempting to hedge against expected price declines.

Continued and Profound Negative Investor Sentiment

Capitulations are most frequently attributed to investors emotionally "giving up," rather than to external forces like changes in the fundamental outlook of a company. This negative investor sentiment may be the cause (or effect) of reaction and opinion communicated by the media, analysts, traders, or other investors.
 

Why Does Capitulation Matter?

There is no guaranteed way to spot capitulation before it happens or while it is happening. However, because capitulations generally reflect the final bottoming-out of a security or market, prices typically increase after a capitulation. Thus, capitulations can also signal the beginning of a turnaround.