What is capitulation trade?
To answer this question, we must first define capitulation. In the investment world, capitulation is a belief that an asset or market has reached its lowest point and that further declines will be limited to small amounts (or even cease altogether). The term derives from the word capitulate, which means to surrender or to concede.
In finance and investing, capitulation often occurs when investors have been depressed by continuous price declines to the point where they have given up hope of recovery and sell their positions, increasing the supply of stock in the market and lowering prices even further.
Definition of capitulation
In finance and investing, capitulation is a situation in which the investors give up hope or stop believing in the future of a company. This can happen when the company’s share price falls by more than 90%.
When this happens, it signals to investors that the company’s fundamentals are not sound. Investors may also be afraid of other factors like insolvency, bankruptcy, or reputational risk.
A common misconception is that a stock or asset is suddenly cheap in a capitulation scenario. In fact, an asset or stock can be cheap for other reasons. For example, investors may panic sell a good company at bad prices due to fear that it might go bankrupt.
They may not stop to consider that its assets might hold up in bankruptcy court and instead assume it’s no longer worth any money. In reality, assets like property never lose their intrinsic value and can become even more valuable when they are sold at reasonable prices.
Capitulation as an indicator
Capitulation is when investors are so convinced that a particular security or market will decline, that they sell off all their holdings. Capitulation is an indicator of market panic, where the majority of people think the price will go down no matter what it does.
This is different than selling at a loss or taking a profit on an investment because capitulation means that the investor has lost faith in the security and doesn’t care what happens to it anymore.
To understand capitulation better, let’s explore why these types of trades happen.
Capitulation can occur in one of two ways: internal or external causes. Internal causes refer to events within an industry that cause investors to lose faith in certain securities, while external causes are events outside an industry which impact its securities negatively.
The Enron stock is a good example of an internal capitulation that occurred on December 2, 2001. The company was in bankruptcy and had to pay off $285 million of debt by December 10th. Since they were so far behind schedule, there was no way that they could make up for it even if they could raise more money.
Investors knew it was over, so they gave up all hope that there would be a positive resolution to Enron’s problems. They sold off all their stock to make back what little bit of money they had invested in Enron during its heyday just a few years before.
As we now know, things only got worse from there. Eventually, the company filed for bankruptcy and eventually settled with shareholders who sued them for failing to disclose information about the true state of affairs .
One final point on why capitulation occurs: Bear markets suck away all the value from the stock market over time until all stocks have been reduced to their worth as stocks trading indices. When this finally happens, capitulation takes place as holders cannot wait any longer for a recovery to take hold – they’re done with waiting!
Capitulation as a trading strategy
Capitulation trading is a strategy that takes advantage of other investors’ fear to make a quick profit. This strategy involves getting out of a position before it’s too late.
For example, if you own shares in a company and the price falls drastically, you could sell those shares while they are still worth something. The price has to be falling very rapidly for this strategy to work, but it can be very lucrative when executed correctly. However, there are many risks associated with capitulation trading because it is difficult to time the market correctly.
Capitulation as a sign of market exhaustion
A capitulation trade is a trade that is considered to be an extreme outcome of the market. This is a sign of market exhaustion where an investor or trader has realized that the trend will not reverse, so they make a last ditch effort to sell their position at what they believe is the highest price possible before it drops to zero.
The term, capitulation originates from military tactics where one side would lose all will to fight so they would raise a flag as a sign of surrender. A capitulation trade in stocks and investments may represent an oversold position in either direction, but it’s most often seen as a last-ditch effort by bears trying to ensure that prices don’t rise any higher than what they’re currently at.
Capitulation trades in stocks can be short or long positions, but they’re generally used by bears that want to capitalize on an oversold position. They’re a sign of market exhaustion where an investor realizes that the trend will not reverse so they sell their position at what they believe is near maximum prices.
This is usually seen as a bearish move because it’s caused by investors losing faith in gains, but it can actually work as a catalyst for bulls because they’re often selling at or near market bottoms when capitulation trades occur.
Capitulation as a contrarian signal
Capitulation is a contrarian signal of a trend reversal. Investors may capitulate when they have been invested in a declining market for an extended period of time, and finally decide to sell their position.
The word itself comes from the Latin word capitulum, which means chapter or section. In finance, capitulation refers to the point where an investor has given up hope on the investment that he or she is holding onto for so long, leading them to sell at any price.
In essence, capitulation is a psychological phenomenon that has investors selling out at such panic prices that it tells you a change in trend is about to happen. The market in which such activity happens is usually either experiencing a long-term uptrend, or else is in a very long down-trend.
Since these two conditions differ from one another, there are actually two different types of capitulation signals. In an uptrend, late-comers may sell out of their positions due to fear that they missed out on earlier opportunities for profit, thus leading to high volume selling. In a downtrend, on the other hand, many investors give up hope and begin to liquidate their holdings by selling them all at once – again resulting in high volume selling.
Capitulation as a bullish signal
The word capitulation is an interesting one. The term originally came from the Latin capitulare, meaning to conclude or sum up. In finance, it has a more specific meaning, referring to a situation in which investors give up on further price increases for a particular asset.
When this happens, we say that the market has capitulated. Capitulation as a bullish signal is something that many traders look for because it can indicate that there are no buyers left in the market and that a new bull trend is about to start.
If you look for capitulations, you need to make sure that you are also able to spot bullish reversal signals in order to complete your trading setup. Some of these other conditions include improving economic data, weakening bearish sentiment and bullish volume trends.
Only then will your strategy become effective, especially since a market can stay in a capitulation condition for quite some time before it gives up on price increases altogether.
Conclusion
In conclusion, capitulation is a state of intense frustration that causes traders to panic. It can be caused by any number of factors, but the end result is always the same – it’s time to sell everything. And since the word capitulation means surrender, this is the last chance traders have to get out before they’re forced out by market forces.
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