In Finance, what is Capitulation?

Capitulation is a term used by investors to describe a sudden decline in the value of a stock when many investors sell the same stock. A company's investors sometimes rapidly sell off the stock to get out of the market for investment in other ventures. Most large stock exchanges have safeguards in place to prevent catastrophic market crashes as a result of capitulation.

A stock is a purchased portion of a company, called a share, that entitles the owner to a measure of the company's profits. Stocks are bought and sold on stock exchange markets. At these markets, investors can make money buying stocks at a low value and selling them for a profit. Investors in the stock market can lose money if the stocks they buy decline in value after they are purchased. While some stock market investors buy stock in a company as a long-term investment, some investors called day traders buy and sell stocks quickly to make a profit from more short-term changes in their value.

Panic selling, a wave of sweeping stock sales that causes a plunge in the stock market, is often the cause of capitulation. A nervous investor with limited spare capital might react to a drop in the value of the stock he owns by selling all of that stock in hopes of reinvesting the remaining money. If a lot of stock market investors have the same reaction, the resulting stock sales can be large enough to make an impact on the total stock price, causing it to drop rapidly. The price crashes that come with capitulation can cause a chain reaction drop in stock market prices, especially if stockholders react to the initial stock market value drop by selling their shares in turn. Usually a result of widespread emotional reaction to market changes, panic selling causes most stock market crashes.

Investors sometimes attempt to make financial gains using capitulation by buying stock when they feel that the falling stock has bottomed out. When a stock has bottomed out, that means the stock price has reached the lowest point that it is going to reach. By purchasing a stock after it appears to have bottomed out, an investor can reasonably guess that she is buying stock at a price low enough to easily show returns when the stock price recovers from the drop. Typically, once capitulation fully occurs, a stock recovers, but deciding when to buy low can be tricky. Predicting whether a stock has fully capitulated is difficult to do accurately until the market trends are digested and studied after the fact.