What is Capitulation?

The Indian stock market is one of the best places to realize higher returns than any other financial instrument and multiply wealth by a hefty margin. However, it will be a lie to say it is for the light-hearted. Investing in stocks requires immense patience and discipline on the part of investors, as volatility is a common factor in the share market As demand and supply forces influence the price of a stock it can result in heavy price fluctuations.

This is the chain reaction that goes on in the stock market, confusing an individual investor on whether to cut the losses by selling or wait for the long term and hope the stock rises in its price again. If you have ever encountered this situation, this blog will detail a stock market situation known as Capitulation that will help you to make informed investing decisions.

Understand the Capitulation

In simple terms, Capitulation means to give up or surrender something. However, in financial terms, Capitulation meaning is different. Here, it means to sell your stocks at a loss willingly only to avoid further losses. In Capitulation, the investors believe that the stock will only fall more in its prices and decide to sell them so that there are no more losses from the current levels. By doing so, the investors give up potential future gains along with a chunk of the capital that they initially invested. As they incur losses, the situation of Capitulation is always considered negative for the investors in the stock market.

How does Capitulation work?

Capitulation is feared and avoided at all costs by many investors. However, when they believe that their stock has fallen to a level that will take years for it to be profitable, they panic and sell the stock to cut their losses. For a better understanding of the Capitulation definition, consider the following example:

Suppose you bought 100 shares of ABC company at Rs 500. Owing to negative external factors such as a bad quarter, a plummeting share price that has reached Rs 300. Now, you have two options: either hold the stock for the long term and hope the price goes above Rs 500, or sell it right now and realize the current loss. If you choose the latter and sell the stocks, you have achieved Capitulation.

Causes of Capitulation

Why does the market reach Capitulation? It depends entirely on the volume of the stock and stock investing trends. If a majority of investors think the stock is not good for the long term, a massive sell-off happens, and the price declines further. If investors had held the stock, the volume would have kept stable along with the price. When there is a massive sell-off across the entire market, the situation of Capitulation occurs.

Some causes of Capitulation are:

• Dipping financial performance.
• Cash withdrawal by Mutual Funds.
• Change in market trend.
• Increase in derivative ratio.
• Negative market and investor sentiment.

However, even when Capitulation is deemed negative by the existing investors, it is taken as a positive sign for those looking to invest further. Capitulation is a sign that the stock price has hit its bottom. As investors who wanted to sell or sold in panic are already excluded, new investors find the low price intriguing and begin to buy the stocks for the long term. The massive buying increases the buy volume of the stock and drives the stock price higher and to new levels from its bottom Capitulation price.

Final Word

If you have extensive knowledge about the financial market, you can analyze Capitulation for any stock and make an informed decision. Capitulation prices can be the best time to buy a stock. However, you should always do due diligence to understand the factors that reduced stock prices. If it is temporary, you can use the Capitulation price as a good entry point.