The difference between bottoming out and a fall

Whether in battle or in the market, one thing that differentiates a psychologically-lost investor and a triumphant soldier is persistence. And when insurmountable odds are against you, even a rock-solid persistence doesn?t seem enough and the annoyingly unfortunate result you see is: SURRENDER. With the markets traversing an unpredictable path, expectations of any gain is perceived to be a ?pipe dream’. But even as experts say ?high pessimism? and ?alluringly cheaper price? form one of the best combinations of prudent buying, what blinds the faith of investors is the mental block that ?all is lost.?

And when such behaviour sets in, in market parlance, it is termed as ?capitulation.?

In the stock market, capitulation is associated with “giving up” any previous gains in stock price, as investors sell equities in an effort to get out of the market and into less risky investments. A true capitulation involves extremely high volume and sharp declines. It usually is indicated by panic selling.

After capitulation selling, it is thought that there are great bargains to be had. The belief is that everyone who wants to get out of a stock, for any reason (including forced selling due to margin calls), has sold. The price should then, theoretically, reverse or bounce off the lows. In other words, some investors believe that true capitulation is the sign of a bottom

Everyone expects the equity market to recover or bottomed-out in a downfall trend to regain the loss. Here high volume is the key thing to note.

In this, high volume is followed by maximum share of delivery unlike otherwise. In this event, a majority of the investors lose patience and sell their entire holdings in panic, eroding their maximum wealth. Investors lose trust in the equity market, which becomes a risky proposition from the lucrative opportunity it was before.

What you should do

? Foremost rule: Believe in your ?selection?. Instead of adopting a frenzied search for better and safe investments avenues to park their money and losing your hard-earned money, what you should do is keep a tab of the news development of the companies you have invested in. And if a news is propitious to you, you can increase your exposure to the company, considering the potency, and viability of the news.

? Second rule: Wait for the dust to settle. A majority of the investors who entered at a higher level think in terms of short-term gain but hold it for long-term and wait to recover their investment. This type of investor should adopt the stop-loss strategy. For instance, 10% or 30% would make sense in such times. You need to wait for the market to correct and enter at lower levels after seeing a clear trend. And if you cannot book losses, staying invested makes sense, than repenting later. Because investing for the long-term should compensate for the risk-reward ratio.

? Third rule: Understand what is happening. Now you could think whether and why this event should take place for the reversal? It is true that such type of pain should not occur in the market, considering the loss to investors and faith diminishing. Technical analysts believe that currently the market is in bear phase. The market behaves in a certain fashion to get a pull back or U-turn. And what you need to look at is the supply-demand factor. When the demand is higher then the supply of shares, the share price goes up and vice versa. One more thing worth mentioning here is that if majority of shares are scattered with large investor base, the probability of the share price going up is less because the sellers who are holding the shares are then more in the market to buy.

Capitulation is both positive and negative for the market as a whole. It is positive because the market may not go down from this level and would become a strong support. Also, new investors can enter as the long-term uptrend is now visible. It is negative for investors who would book heavy losses due to an unexpected and hasty decline. Capitulation is been misused instead of correction.

Correction is a temporary dip due to profit booking and pulls back after some time. There may not be high volumes in case of correction and it may extend for a couple of months. If one looks at the Sensex after the steep fall in between mid-January to mid-March 2008, there was a pullback with some volumes at lower level. However, the pullback was temporary and actually was used as an opportunity by traders to exit the contour that ended in May 2008.

It is difficult to gauge when and how long a capitulation phase, if it happens, would sustain. This has to do to with the psychological impact on a majority of investors than anything. However, ?time? is an important factor. Bigger the period for which the market is in a negative trend or in a bearish phase, higher is the probability of capitulation.

However, what exacerbates things in the markets is when due to the low patience level of the investors, there is a frenzied sell-off. And when this happens heavily, prices go down sharply. Experts believe that this phase may come at a level when the market declines by 30% or may be 70%.