With most stock markets at or near all-time highs, I thought this might be a good time to talk about market capitulation and why you should be aware of this phenomenon. It is important to understand that considerable experience is needed to properly identify and trade capitulation that can occur at all-time highs or solid resistance that cannot be broken. A simple definition of capitulation is when long positions are abandoned and a period of heavy selling occurs when traders experience panic and are eager to exit their positions to avoid realized gains or losses. A simpler explanation would include the term panic selling.
One way to identify capitulation, as opposed to a normal corrective move lower, is to watch volume closely. Surrender gains momentum as panic selling takes over the mindset of confused traders. Volume will increase and the momentum of panic selling increases as the level of fear increases. I think it is important to mention the word fear. Capitulation is directly correlated with fear, and that fear can continue for quite some time as scared investors exit their positions.
Volume is key to identifying this market move and you will see much higher volume levels than normal. Without a doubt, the volume levels can be absolutely massive. Newer traders, especially those who started after the market crash of 2007-2009, will see volume numbers so huge relative to the volume levels they have been trading for the last 7 years.
I can vividly remember the market crash of 1987. Although I had been trading for several years, my experience was with a rapidly bullish market. We thought the sky was the limit and had no experience with a serious move lower. I can also recall the speed and breadth of the liquidation. I had never seen volume numbers reach the levels that the rapid move down was creating. Frankly, it was terrifying. He had the typical mindset of a novice trader. During my early years I thought the market was headed for the moon. As the move down gained momentum, I was sure the stock market was going to go to zero.
In 1987, most of the sell-off was attributed to program trading, and the NYSE and other exchanges took steps to control the influence of these programs. These measures are known as circuit breakers and companies are forced to cancel their trading program in the hope that the market will normalize the movement. Having experienced several capitulation moves, my general opinion is that breakouts scare traders even more.
I suspect that we will see a capitulation at some point in the future as this market tops out and the bullish momentum begins to deteriorate. If you can correctly identify one of these moves, you can make a lot of money by shorting it. As always, best of luck in your negotiation.
