What is 'market capitulation' and how you can identify such a move

'Capitulation' refers to a phenomenon where investors liquidate their positions during periods of extended decline in the stock price for the fear of incurring a bigger loss. This panic selling may even emerge due to margin calls and increase in futures & options (F&O) margins, etc. On the other hand, some believe that capitulation can lead to exhaustion of selling pressure and hence provide a fresh buying opportunity.

What does capitulation tell you?

o The stock market is likely to see a bottom once the capitulation subsides.

o Squaring off one's position during capitulation gives traders a sense of relief and the strength to execute fresh trades

o The capitulation is difficult to forecast. However, if predicted accurately, then benefits can be enormous.

o The scope of the capitulation period is extremely difficult to gauge, yet the outcome are known only after the period is over.

How to identify capitulation?

Capitulation can be effective in various ways as it can lead to selling exhaustion, thereby prompting fresh stock buying. Volume plays a crucial role in capitulation. Whenever a stock or index starts to fall with heavy volumes, one can observe panic selling. That said, one needs to gauge the momentum through various candlestick patterns or formation for confirmation. Several technical indicators also help spot a capitulation move.

Time Frames to identify capitulation

For a short-term reversal, a weekly or monthly chart supports can provide a decent signal. However, from a medium-term perspective, quarterly chart to yearly chart helps determine the ongoing trend. Since capitulation helps ascertain the fear among investors, it can provide a good opportunity to exit from given positions in a stock in time. For investors looking for opportunities from a long-term view, liquidating stocks with limited loss helps them regain the strength to enter the market with new enthusiasm.

Investor Psychology

This behavior is heavily influenced by various market news, FII inflow/ outflow, fear of losing out, etc. The situation tends to live for several days to months and may have significant impact on investments. Over the years, investors have become highly cautious and now prefer to buy stocks a little pricier but only after the negative sentiment ebbs.

There is also the tendency of investors to shift from one segment to another during such times. Investors may find equity highly risky at times and may thus shift to bonds, commodity, currency etc. This shift may further dampen the stability of the respective market.

To lift the mood of the overall markets, the regulator often brings in policies that restores sentiment. This could be in the form of “Ban on short selling”, increase in margin of derivative segment, strengthening the information of  highly risky assets  and regulating the rumors / news for the safeguard of investors.