What is capitulation?

Capitulation occurs when investors sell off their stocks rapidly because they believe that prices will continue to fall. This mass selling typically marks the end of a downturn in the market – when the market hits rock bottom.

Investors, in large numbers, have decided to cut their losses and sell their shares. Because so many of them are involved, it often leads to a sharp decline in stock prices.

Capitulation, when used in a military context, means to give up or surrender. Likewise, in the markets, investors give up and sell.

The Corporate Finance Institute (CFI) has the following definition of the term:

“Capitulation refers to a situation in which investors/traders liquidate their existing long stock position during an extended stock price decline. It can be viewed as the moment in which investors/traders lose hope in their long position and accept losses.”

Capitulation – widespread pessimism

Capitulation is triggered by widespread pessimism after a long period of declining share prices.
Investors initially try to hold onto their stocks in an attempt to endure the downturn, expecting the market to pick up again. However, as the decline persists, sentiment shifts from optimism to fear, and the urge to sell intensifies.

When the majority of investors, including institutional investors such as mutual funds, pension funds, and insurance companies, reach this level of pessimism, they sell their holdings. We call this collective action capitulation.

Crowd of investors panicking as they see stock prices falling on a screen - plus a definition of the term Capitulation
Image created by Market Business News.

Market bottoms out

Capitulation often precedes the bottoming out of the market, that is, when the market reaches its lowest point before starting to recover.

After a mass sell-off, there are fewer sellers left in the market, which can halt the decline of stock prices. This paves the way for a potential recovery.

Sometimes, the market takes time to pick up. It may take a while for confidence to return before prices start rising again.

Capitulation is a concept that is often easier to identify after it has occurred, rather than during the event.

Conclusion

Capitulation occurs in the financial markets when investors “give up” and there is mass selling of shares. It is a significant turn in market dynamics, signaling a possible end to falling stock prices and perhaps the start of market stabilization.