Stock Market Capitulation

The stock market seems to have periods when it acts somewhat logically and periods when it acts on pure emotion. When logic goes out the window and emotion is the driving force then the market it at a top or at a bottom. When it market reaches the bottom it is called capitulation or the point when investors give into emotion and essentially throw in the towel.

How can you tell when capitulation occurs? Here are 5 signs:

1. Wild swing during the day. The events of October 10th represent this nicely. The Dow opened down big and kept going down which means that people were selling just to get out and in the afternoon a large rally happened where institutional buyers saw it as a golden buying opportunity. A previous blog indicated that this looked like a market bottom and it was time to buy. October 10th gave us the largest 1 day price swing in the history of the Dow. It was massive selling by people who had finally had enough and emotionally had to get out.
2. Another sign is when the common belief is that it is going to keep going down and any sense of reason is discarded. For example, on Monday November 24th, when the Dow was about 8,000 CNBC reported that about 70% of people who responded to a survey question thought that the Dow was headed to 6,000. Now many experts have said that now was a great time to buy. However, the people who are investing based on emotion have an underlying belief that it will keep going down regardless of the number.
3. When you read it in the newspaper that long time investors have quit. For example, the Monday November 24th Wall Street Journal had an article: "Fear and Frustration: Some Investors Quit." The article gave examples of people who had been long time investors in the stock market and finally could not take it anymore and walked away.
4. When bad news occurs and the market keeps going up. The news in the Tuesday November 25th Charlotte Observer was that home sales had fallen more than expected in October. On Monday November 24th it was reported that existing home sales dropped on average 3.1% nationwide during the month of October. In the past, news like this would have send the Dow tumbling down. In spite of this news the Dow rose.
5. When you are tired of hearing about it, can not turn on the news, and physically feel sick to your stomach. This is a good indicator that you are at the point of capitulation and the question is will you capitulate or not.

What does this mean? If you have not already changed your investments to prepare for a recovery in the stock market now would be a good time to do it. A recovery always follows capitulation.