What Is Capitulation?
Capitulation in finance describes the dramatic surge of selling pressure in a declining market or security that marks a mass surrender by investors. The resulting dramatic drop in market prices can mark the end of a decline, since those who didn't sell during a panic are unlikely to do so soon after.
Capitulation typically follows significant downturns in price, which can take place even as many investors remain bullish. As the downturn accelerates, it reaches a point where the selling by the investors unwilling to suffer further losses snowballs, leading to a dramatic plunge in price.
The heavy trading volume accompanying the decline shakes out "weak hands"—the investors lacking conviction—and replaces them with more risk-tolerant holders who may not have suffered prior losses and were willing to buy at the end of a protracted decline capped with a dramatic drop.
Traders look for unusually high trading volume accompanying sharp declines in price to signal capitulation. They try to anticipate the surest sign of a capitulation: the rebound in price that follows once the panic selling has run its course.
KEY TAKEAWAYS
- Capitulation happens when a significant proportion of investors succumbs to fear and sells over a short period of time, causing the price of a security or a market to drop sharply amid high trading volume.
- Capitulation marks a short-term low in the price and is followed by at least a relief rally.
- Until the price rebounds significantly, there can be no assurance the apparent "capitulation" won't be followed by additional dramatic drops.
- Capitulation causes heavy turnover among investors, enabling a rebound by replacing risk-averse sellers with risk-tolerant buyers, but it can't guarantee those buyers won't eventually sell even lower.