What is Capitulation?
In the world of finance, the concept of capitulation is brought up into conversation when an investor is no longer interested in making a valid effort to regain lost profits due to the declining price of the underlying asset on his position. Though there is no specific time frame set for capitulation, it commonly takes place when there is high volatility in the markets as the asset is sliding downwards. Usually, the bear market influences investors to capitulate or make a forced sale. Once the capitulation is underway, the smart money investors are jumping up and down for the opportunity to purchase their favorite assets at a discounted price. However, the hard truth here is that these capitulations in the market are the result of the psychological pressures borne by day traders and market makers liquidating their position. Investors usually cannot figure out that they’re in a stage of capitulation until the market is already on the reversal to the local highs.
According to the Wikipedia definition, capitulation stands for giving up or surrendering. Capitulation will sneak up on you and before you know it, you’re back full swing in a bullish momentum to new highs. For instance, the value of an asset that you bought has declined by 20%. In this scenario, you have the choice of either waiting patiently for the asset’s underlying price to shoot up again or realize the paper loss by selling it for an actual realized loss of money. Most investors opt for waiting for the price of the asset to spike upwards again and during this period there is some stability in the underlying price. However, during a market crisis, if most investors choose to capitulate and sell the asset, the price will fall steadily. This pattern of repeated selling by investors during times of crisis causes market capitulation. Shortly after almost every investor who wished to sell the asset has already sold it, there are only buyers left in the market, scooping up the asset at discounted rates. From here, there is a great chance that the buyer’s presence will raise the price of the underlying asset. The only downside of capitulation is that it is almost near impossible to predict it until its over. Most of the time, investors will only nod to the prices after the capitulation in the market has taken place. In this next section, we’re going to breakdown a sample of market capitulation on the Bitcoin chart.
Looking back at the summer cycle in 2020 on the chart of Bitcoin on the daily (1D) time frame, we can see a period of capitulation during the months of September and October. It is seen here that from the dip at the end of August after Bitcoin reached new highs for the first time since the 2017 bull market, BTC entered a period of capitulation that wasn’t visible to the everyday investor until after it broke out back above $12,000. However, I noticed this was capitulation in the middle of September and held strong onto my long position, only to find my position validated by the market a month later. This is how I analyzed the capitulation.
Coming off a strong month I noticed that Bitcoin hadn’t back tested the $9950 level of support, which is crucial for BTC to continue moving up in price. A dump was evident, and it came very fast. In two days, the Spot price of Bitcoin went from $12,000 to $9950. The reason I figured it was capitulation is because after the span of 7 daily candles, we didn’t find a single daily closure underneath the $9,950 level and frankly none of these candles even came close to closing below there. After that weekly close I was convinced that this was capitulation, and it was only going to be a matter of time before the markets reversed.
The key here is noticing the hammer candlestick patterns in the market, and if you haven’t checked out that article yet, I highly suggest you do so and then circle back to this one. Anyways, the hammer candlestick represents a bottom in the market and those bulls have regained their control. I understand that despite the panic selling that occurs during the trading period, the prices are still closing reasonably close to their open, which shows a slowing and stabilizing downwards momentum resistant to the ongoing panic selling pressure. As time progressed in this capitulation, I drew this upwards channel and eventually Bitcoin broke out of this and started climbing towards higher highs.
Limitations of Capitulation
Market Capitulations are significant market events that can present day traders with multiple opportunities to make significant profit. However, their inherent unpredictability and instability mean that they also present corresponding risks to investors and traders who attempt to trade them.
It is very difficult to time the market and even more difficult to time the market capitulation. Once it is increasingly clear when the capitulation process is taking place, it is usually too late to profit from it.
Investors and day traders attempting to trade in a market capitulation can use a variety of technical indicators to help them sort through the rapidly changing price action to identify where in the capitulation process they’re at. Hammer indicators are very useful for identifying the bottom of a market capitulation but should not be the basis for your entire investment. Identifying proper capitulation before the general market population takes years of technical analysis practice and even then, the chances are you’ll miss it.