Stock Market Capitulation and the Opportunity it Creates

By Stock Research Pro • October 17th, 2009

Stock market capitulation refers to investors “giving up” on stocks or the market in general in favor of a move to less risky investments. Capitulation is actually a military term for surrender but is applied to stock investor behavior when a severe downturn in prices leads to high-volume panic selling. Margin calls often play a significant role in capitulations.

The Role of Fear in Stock Market Capitulation

Fear and anxiety are major contributors to stock market investor behavior. While periodic downturns are seen by most as regular parts of the business cycle, circumstances can develop that cause investors to abandon all rational decision making in favor of fear-driven decisions that result in an irrational, oversold market. Generally speaking, markets do have a tendency to overreact to the upside in good times (greed-driven behavior) and to the downside in bad times.

Capitulation and Contrarian Investing

The opportunity for contrarians, those stock market investors who make investment decisions based on factors outside of prevailing trends, can be considerable after capitulation selling. Those who employ a contrarian style recognize the bargains to be had tend to look out for circumstances where it appears that everyone who wants to (or is forced to) exit a stock position has done so. There is, of course, the potential for great upside when that occurs.

Capitulation, Oversold Conditions, and Fundamental Analysis

Fundamental analysts look to identify oversold conditions (undervalued stocks) through the confirmation of the company’s financial strength, a review of its industry and future growth opportunities, and valuation analysis. The belief among fundamental analysts in that, over the long-term, undervalued stocks will adjust upward appropriately and leverage valuation tools that often include book value, PEG ratio, and discounted cash flow analysis.

The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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