Capitulation is associated with "giving up" any previous gains in stock price as investors sell equities in an effort to get out of the market and into less risky investments. The sole motivation for trading is to get out of the market and seek shelter in "safe" investments such as bonds or your mattress. True capitulation involves extremely high volume and sharp declines. It usually is indicated by panic selling that occurs over a brief time span.
Market capitulation is a term that refers to the final phase of the market cycle. It is when a large amount of investors get scared out of equities and go to cash. This forces the price to bottom, the P/E ratios to look favorable, and, with the majority of potential sellers on the sidelines, a new bull market (or major bear market rally) can begin.
From an investor perspective, it indicates a point in time when investors have decided to give up on trying to recapture lost gains as a result of falling stock prices. Suppose a stock drops by 10%. There are two options: wait it out and hope the stock begins to appreciate, or, realize the loss by selling the stock. If the majority of investors decides to wait it out, then stock price will likely remain relatively stable. However, if the majority of investors decides to capitulate and give up on the stock, then there will be a sharp decline in its price. When this occurrence is significant across the entire market, it is known as market capitulation.
Significance of capitulation
The significance of capitulation lies in its implications. Basic economic factors dictate that large sell volumes drive prices down, while large buy volumes drive prices up.
After capitulation selling, everyone who wants to get out of a stock, for any reason (including forced selling due to margin calls), has sold. The price should then, theoretically, reverse or bounce off the lows. In other words, some investors believe that true capitulation is the sign of a bottom.
Many market professionals consider capitulation to be a sign of a bottom in prices and consequently a good time to buy stocks, as there are great bargains to be had.