What Is Capitulation As It Relates to Trading?

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Since most of the equity markets are at or near all-time highs, I thought that this might be a great time to talk about market capitulation and why you should be aware of this phenomena. It is important to understand that it takes considerable experience to properly identify and trade capitulation which can occur at all-time highs or solid resistance that can’t be broken through. A simple definition of capitulation is when long positions are abandoned and a period of high volume selling occurs as traders experience panic and are anxious to exit their positions to avoid losses or realized profits. A simpler explanation would include the term panic selling.

One way to identify capitulation, as opposed to a normal move corrective move to the downside is to observe volume with scrutiny. Capitulation gains momentum as panic selling grips the mindset of confused traders. The volume will increase and momentum of the panic selling increases as the level of fear increases. I think it is important to mention the word fear. Capitulation is correlated directly with fear and that fear can continue for quite some time as frightened investors bail out of their positions.

Volume is key to identifying this market move and you will observe far higher levels of volume than is normal. To be sure, the volume levels can be absolutely massive. Newer traders, especially those that started after the 2007-2009 market meltdown will volume see volume numbers that enormous relative to the volume levels they have been trading for the last 7 years.

I can vividly remember the market crash of 1987. Though I had been trading for a number of years, my experience was with a rapid upward trending market. We thought the sky was the limit and had no experience with a serious move to the downside. I can also remember the speed and breadth of the sell-off. I’d never seen volume numbers reach the levels the rapid move to the downside was creating. Frankly, it was frightening. I had the typical mindset of a novice trader. I thought during my early years that the market was headed for the moon. As the downside move gained momentum I was sure the stock market was going to hit zero.

In 1987, most of the sell-off was blamed on program trading and the NYSE and other exchanges have taken measures to control the influence of these programs. These measures are referred to as circuit breakers and companies are forced to terminate their program trading in hopes the market will normalize movement. Having experienced several capitulation moves, my general opinion is that the circuit breakers panic traders even further.

I suspect we will see a capitulation sometime in the future as this market tops out and upward momentum starts to deteriorate. If you can properly identify one of these moves there is great money to be made by trading short. As always, best of luck in your trading



Source by David S. Adams

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