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What Is Capitulation?

Capitulation refers to a phenomenon in the financial market where investors sell their positions in security, usually due to the fear of incurring more loss, during periods of extended declines.

Deeper Definition

Capitulation refers to a period of panic selling in the financial market. It occurs when investors and traders lose faith in an asset and stop every attempt to recapture lost gains instead of selling it at a loss. Usually, when capitulation is over, the market either goes into a consolidation period or an uptrend that potentially signals the beginning of a bull market.

Capitulation is a military term that means to surrender to a superior army. In the financial market, investors and traders surrender their positions to prevailing market forces. For instance, imagine you bought $5000 worth of bitcoin three weeks ago, and today it is worth $3500 due to bitcoin’s price falling. You can continue holding your position until whenever the bitcoin price goes up again, you’ll recover your losses and make gains, or you can sell your holdings if you believe that bitcoin’s price will not go up. Doing the latter is capitulation.

Capitulation has significant implications, regardless of the financial market. Although it is difficult to forecast it, if predicted accurately, then benefits can be enormous. For instance, a trader may enter a short position to profit from the declining prices. Traders and investors recognize capitulation by the extreme downward pressure on market prices, driving it lower and lower until it reaches a bottom. Professional traders and investors often consider it a good signal to buy more assets because a significant sell-off ultimately drives the price down further, making it cheaper for interested buyers to accumulate. As buyers start buying, they eventually push prices back up.

Capitulation Example

Travis is a stock market investor that specializes in buying stocks with long-term potentials. Several months ago, he bought a stock that checks his boxes of what makes a good investment. Recently, there were rumors about the government wanting to regulate certain aspects of an industry, which may affect the future of the company. The news causes many investors to dump their stocks, driving the prices down. Travis holds his position for some days hoping that the decline will soon be over. However, it doesn’t stop. Believing all hope was lost, he decides to join other investors by selling his holdings.

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