Making Money from a Capitulation Market Bottom
Blueprint for Playing a Capitulation Bottom By Dr. Van Tharp Trading Education Institute
Capitulation is the kind of panic selling that builds momentum, causing a dramatic decline in stock prices and dropping them to a "bottom." This floor is often near or below previous support levels. A bottom is a mythical place where almost everything looks cheap enough to buy. The bottom, by definition, marks a turn in the market, and is followed by a broad, sustained rally. During a "capitulative" selling period, market watchers talk incessantly about whether there is enough fear in the market. — Dictionary of Financial Terms
True capitulation bottoms are pretty darn rare. Yet in today’s “all or nothing” swashbuckling market style, it seems that we are seeing them more and more often.
So I’d like to review three major bottoms that have happened in the past 11 months — mainly because I was intimately involved in them from a trading perspective. I also think they provide a very good overview of what happens after the selling stops - and that gives us a good roadmap for catching the next one.
Capitulation Bottom #1: Brexit Vote, June 2016
Last June, all the financial world could talk about was the Brexit vote. I don’t need to dwell on what happened — Brexit surprised most pundits and the equity markets reacted with an initial big drop. Traders could not make up their mind about whether Brexit was good or bad for global financial markets so they took until Monday to find the final bottom of the move. Here is an hourly bar chart of the Dow Futures contract:
This indecision made the original play a little tougher to grab, but ultimately, it was very successful.
Capitulation Bottom #2: U.S. Presidential Election, November 2016
This trade had similarities to the Brexit trade: pollsters predicted poorly, the populist vote won, and most of the significant activity happened in overnight trading.
The financial markets were far more certain in their love for this election result so we got an extremely tradeable classic capitulation bottom. Here’s what it looked like on the chart for the Dow Futures again:
This capitulation move formed a traditional “V” bottom with a retrace after the first leg up. That retracement gave an ideal entry.
This classic pattern repeated (to much less fanfare, might I add), just a few weeks ago,
Capitulation Bottom #3: Oil Finds a Mystery Bottom, May 2017
Unlike the previous two trades, this bottom happened far away from the media spotlight. Fact is — it was very easy to miss — but that’s why I always check the markets before I turn in for the night.
My bedtime routine is pretty simple. I enjoy evenings either teaching a youth group, watching TV with my lovely and talented wife, or catching up on some reading. After that, I wrap up the night by letting out our 10-pound Havanese dog named Rocky for his last bio break of the evening.
Right before I run upstairs to brush my teeth, say my prayers and tuck in for the night, I stop by my computer screens and make a quick run through of the markets. Nothing too sophisticated — I check the S&P 500 overnight trading. Then I look at the markets for Japan and China to see the first part of their trading day. Lastly I run through gold, silver and oil to see how they’re trading.
I was right at the end of my scans on Thursday night, May 4th and I saw that oil had plummeted — more like dropped off a cliff. This 30 minute bar chart shows what the screen looked like around midnight:
Wow! I was certain there was breaking news because price moves this big usually happen for one of several reasons.
There is geopolitical unrest (armed hostilities, terrorist activities in the Mid-East, etc.).
There’s big supply news like a natural disaster that would affect production or
OPEC makes a big announcement.
I checked my normal news feeds — nothing. I went to specialty energy news sites. Zero. Twitter? Goose egg… I even zipped through trade message boards where some knowledgeable people that I know post. Lots of activity, but no news. “Nothing” had happened. Yet when I looked at the one-minute chart, the drop looked even more severe:
Now, oil had already dropped 19% in the past three weeks BEFORE this midnight tumble. There was only one logical conclusion: in the low volume overnight trading, a collapse on zero news meant capitulation — buyers gave up and prices plummeted.
As I said earlier, capitulation bottoms are pretty unusual and trying to pick one is tough business. That’s why people say it’s like “trying to catch a falling knife”. I like to get extra confirmation before giving a green light for an intermediate bottom trade like this one in crude. Here’s how the entry decision sequence looked on the chart coming off of that bottom:
This trade was in the green almost from the moment price broke that retracement high. Here’s how it played out:
Capitulation bottoms display raw emotion in the market and when you find one in progress, you can usually predict their outcomes. While you would not be able to play these as every day or “bread and butter” trades, it is important to keep capitulation bottom patterns on your opportunistic radar screen.
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