Profiting From Capitulation
Recommended strategy which capitalizes on capitulation: Ten Steps To Profitable Trading.
I’d like to go into a little detail about something which happens to all stocks every now and again to a greater or lesser degree. It’s something called capitulation.
It presents a very profitable short to medium term trading opportunity because it marks a sharp turnaround in price and, for a stock which over the longer term has been rising steadily, it almost always marks the beginning of a long rally.
The opportunity in capitulation occurs when an otherwise upward heading stock has a few months down drift. Perhaps it hasn’t had anything good to report. Perhaps it’s just been off the radar for too long. It gets on the news because it had fallen so far for so long.
The analysts and other talking heads are slamming it for their own reasons. Perhaps there is bad news (real or fabricated – but certainly exaggerated) but either way the bad press it gets forces the last group of hopeful traders to finally throw in the towel and sell.
This ‘rush to sell’ by this final group causes the stock to gap way down on market open, and the price continues to free fall after opening for about 30 minutes.
At about 30 minutes, the last of the panic sellers have exited and the selling pressure dies off. At this point a bunch of buyers rush in and the stock price turns, and as the buying volume increases with few sellers in sight, the price rises sharply back up.
As the price is so low after many weeks of dropping the buying continues and the stock slowly rises back to its moving averages again, and beyond.
This is capitulation, and those who buy in on ‘capitulation day’ and hold it for a few weeks can make a lot of money.
In terms of risk/reward, capitulation it’s a relatively low risk way of buying into a stock at a very low price, thus making even more money from an extra dip it took. Let’s take a look in a little more detail.
Forgive me if I seem to be over-simplifying it a little but I’d like to allow those new to trading to be able to understand it too. Stock prices will change direction in two ways, either they have a ‘slow’ but choppy turnaround by following some sort of temporary bottom, or they have a sharp spike downwards during single day’s trading, which they recover from very quickly, usually within a few hours.
The quick trading day sharp spike downwards is stock capitulation. It is when the leftover traders still holding onto big losses finally give up and sell. These traders are the dumb money who actually bought when the stock last hit a high high and everyone was telling them to buy.
Since then, they all have seen their stock price plummet by perhaps as much as 30% or more in the previous few weeks. Perhaps you have been one of them in the past.
‘Capitulation day’ as we like to call it is when a stock gets very bad press after an long downward trend. Traders who are holding on to it watch the news and hear the analysts telling everyone to dump and run. This is different from long term hold investors who will hang on no matter what. The traders however watch the news in despair and decide finally to follow the analysts advice and bail at market open.
This affords a great opportunity to buy if you have your finger near the trigger. Of course, when you see the news and hear the analysts telling you to bail, it takes a lot of courage to ignore their advice and buy. We’ve covered in other articles why the analysts would recommend you sell, only to see the stock suddenly reverse direction and make huge gains over the next few weeks, and it’s part of why 90% of traders lose money.
In cases like this you need to learn how to trade with nerves of steel, as it’s very difficult to place a buy order when the news is doom and gloom.
Most of the traders who bought into this stock at the last high were being told at the time to buy, by the very same talking heads. They followed the advice then and are now holding huge losses. Now they listen to the same talking heads advising them to sell, which they do, and now they’ll watch the stock price rise again for a few months. Does that remind you of anybody?
I know it seems counter intuitive but the lesson here is to buy when the analysts and talking heads are telling you to sell, and sell when the analysts and talking heads are telling you to buy.
Only that way will you finally be in the very small minority who actually make money trading.
Oh, and P.S. As always remember to use a stop loss. On capitulation day that can be just below the capitulation day low, usually about 30 minutes after market opening.
There’s a great little trading strategy which covers profiting from capitulation very well. Knowing when it really is capitulation and not just a bad hair day. It’s called the Ten Steps To Profitable Trading and it’s worth a look at, especially for beginners. I’d seriously recommend reading the sales page even if you have no intention to buy, as it summarizes its ‘Ten Steps’ strategy and that’s enough to give you a reasonable idea about what happens during capitulation and how you can profit from it. You can learn more about at besttradingstrategy.com.