26.08.2022

Blog: Capitulation, good time to invest?

Blog: Capitulation, good time to invest?

Many have heard the saying, “When taxi drivers start giving investment tips, it’s time to exit the market,” but how do you know when is a good time to enter the market? Conversely, it could be concluded that the signal is when you no longer hear about investing from anyone. In capitulation, a large portion, especially of the amateur investors, exit the market due to bad investment experience, after which the selling pressure on the market eases and a new bull market can begin.

              
What is capitulation?

Capitulation might be a familiar word to many from the military language, where it refers to the collapse of defense that usually leads to surrender. In investing, capitulation refers to an event where a large portion of investors lose hope in the investment asset and end up selling it. Usually, capitulation is caused by negative news and a sharp drop in the price, after which even more investors sell their investments, pushing the price into even steeper declines. In a way investors capitulate in the face of a fierce downward price movement and exit the market. This sometimes called price capitulation is the most common form of capitulation and is usually what is referred to when talking about capitulation in the markets.

In addition to the price capitulation, a lesser-known capitulation that is based on time can also be seen in the market. In this time-based capitulation, the price of the investment asset does not fall as suddenly as in price capitulation; instead, the price falls or moves sideways for a longer period of time. When the price of the investment does not rise for a long time the investors interest and faith in it starts to wane, and eventually they end up selling. Therefore in time capitulation, investors surrender after a long and exhausting struggle, as their interest in the investment shifts to other things.

Capitulations in the cryptomarket

A good example of price capitulation in the cryptomarket was the bear market in 2018. Bitcoin’s price had reached almost 20 000 dollars in December 2017 after which it turned into a sharp decline. Although the price fell quite quickly there was still also buy pressure in the markets, which was reflected in short but rapid increases in the price in the middle of the downmarket. However, in November 2018 the price suddenly dropped from above 6000 dollars all the way down to below 4000 dollars in a bit over a week, as many investors lost their faith in the market recovery.

The price capitulation of 2018 was also the start for the time-based capitulation in the cryptomarket. Many investors who did not leave the market in the price capitulation did so eventually during the next 2 years. For example, google search trends for bitcoin give some indication of this. Even though after the price capitulation of 2018 the price of Bitcoin rose from below the 4000 dollars to over 12 000 dollars in the next six months, it still dropped back down to below 4000 dollars in the first half of 2020. Bitcoin’s price did not rise above the 2017 high until December of 2020, when many who had invested in it during the 2017 bull market had already exited the market.

In May 2022 there was a collapse of Terra’s LUNA and UST cryptocurrencies, which caused uncertainty in the markets, thus bringing also other cryptocurrencies downward. This event also triggered a common phenomenon to price capitalitions, where the price drop is accelerated by liquidations of leverage positions. Leverage position means that the investor uses loaned money to increase the size of their investment, which increases the price movements of the investment position. If the price falls enough the leverage position is liquidated, which means an enforced sale of the investment in order to cover the loan. If many investors use leverage at the same time and the price suddenly falls, can this trigger a liquidation spiral. In a liquidation spiral, the liquidations increase the selling pressure pushing the price even lower and causing even further liquidations. This can result in a price capitulation where many investors are forced to exit the market as their positions get liquidated.

Are capitulations good investment places?

Historically capitulations have been very good places to invest, but in reality timing the market based on capitulation is very hard. Even though there are countless examples of capitulations, they are very hard to spot except in hindsight. One can try to spot price capitulation by using different indicators, such as the fear and greed index, exchange volumes and liquidations. However, due to the high volatility of the cryptomarkets, the final bottom of the capitulation is very hard to schedule. The bottom of time-based capitulation is even harder to time as the capitulation happens slowly and during a long time period, meaning there isn’t necessarily a clear signal for the bottom.

On the other hand, when an investment asset collapses to zero, it usually happens through capitulation. This makes price capitulations so scary, because the idea of total implosion inevitably crosses one’s mind. However, if the investor believes in the long term success of the investment, it is usually beneficial to just follow the plan for the bear market and to not make any sudden changes. Previous blog post provides some advice on how to make a plan for bear market. So if one’s investment horizon is long, bear markets and capitulation points are good opportunities to lower the average purchase price of the investments.

Summary

Capitulations are events, where many lose their interest and faith in investing and they exit the market. It is usually a very unpleasant situation for many investors, where the fear is often at its highest and some investors even lose their investment due to liquidations. Sometimes capitulations drag out to become time-based capitulations and tire even the most persistent investors out of the market. If, however, investors' time horizon is further ahead and they manage to stick to their investment plan, capitulation points are usually great places to increase investments.

Manu Isto Cryptocurrency specialist
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Last updated: 19.09.2022 10:44
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