All of this conjecture is silly. A bottom will form when it damn well pleases. It doesn't matter what anyone thinks of it - whether they capitulate, what taxi cab drivers and plumbers say about it, or what Nouriel Roubini says. It just matters when people start consuming, lending, borrowing, etc. For one, I'd love Cramer to successfully call the bottom on this one... That would trick everyone who thinks they are so clever... (I'm not saying Cramer knows anything special. I am saying this voodoo gaming of market psychology borders on stupidity).
Capitulation requires a mass exodus from long or short positions. Honestly in this environment I think people have just become complacent. They aren't bothering to review their 401k statements any longer and who can blame them. So I'm with the camp that says we want see a capitulation bottom just a slow round bottom.
Capitulation is a big myth. It doesnt exist, this market had more oversold levels than the previous ones yet it keeps going down while the previous bears eventually stopped and then people looked at it and said 'see there was capitulation in day x', no there wasn't because even more extreme actions failed to produce bottoms
I think capitulation is a short-term sentiment issue. It doesn't seem to give any indication as to what will happen in the medium-term or longer. Medium & long-term moves seem to be driven by fundamentals and more structural factors. But that doesn't mean capitulation is a myth or useless. Betting on rallies when fear reaches tangible levels is a very profitable strategy - ditto in reverse for when shorts panic and cover. However it's a mean-reversion strategy so you need to either use conservative position size and be comfortable scaling into a loser at lower prices, or use short-dated options (my favourite way to trade this kinda thing). Buying into a panic can lose money over the long-term if it's a grinding bear market with multiple temporary panic lows, IF you insist on holding on when complacency returns, rather than booking profits. If you book profits then it's profitable, very profitable. E.g. 2000-2003 had multiple panic bottoms such as Jan 01, Sep 01, two in 2002. I went long on 3 of those occasions and made money because I took profits once the fear had passed and the short-term rally had occurred. If I had held on longer I would have eventually lost money on the 2001 buys, and took unnecessary heat & time on the 2002 purchases before the March 03 bottom came in. So the lesson is not to avoid capitulation, but rather to buy it, and remember to sell out once the fear has all gone, buyers return and the market has spiked 10%+ higher. The conventional wisdom on capitulation says you buy it and then hold on long-term. It's a variant on buy & hold and is definitely wrong if there's a long-term bear market. If you buy into capitulation and then hold, basically you get the trading results of capitulation (usually profitable) but that is then overlayed with the longer-term investment results of buy & hold (which obviously loses money in longer bear markets with more than 1 panic low). It is rather unfair to blame the profitable component of that 2 stage process - the capitulation buying - for the losses made by the 2nd stage of the process - the hanging on via buy & hold. So saying that capitulation is a myth is the opposite extreme and just as mistaken. Summary: playing capitulation is a good TRADING strategy that makes excellent profits for low risk if you know how to do it well. Capitulation is not an investment strategy and if you use it that way you are doing it wrong and will earn buy & hold plus a bit - which in a longer bear market will lose you money. Regarding "oversold levels", more on that in my next post...
Sure there are oversold levels that can be profitable to buy. But thats not people mean by capitulation, what they mean is a broad definition of people 'giving up' on high volume that has no easly testable elements(otherwise it would be easly debunked) and people point at in hindsight do they can keep their illusions that markets are so predictable
The 2007-08 bear has had 6 capitulation lows so far. 2000-2003 had 6 capitulation lows and the last one (March 03) was the bottom. 1929-32 had even more capitulation lows, Japan 1990-2003 also had more. So this market does not have more oversold levels than the previous ones, at least not so far. Each capitulation had a large, sharp rally soon after, so the market did not keep going down (at least not in the time just after the capitulation). It went lower weeks or months later, but there was a very big tradeable rally to play in each case. Also I think the concept of "oversold levels" can be misleading. From what I've experienced, capitulation does not usually seem to be defined by price levels, it is more about sentiment and newsflow. I used to pay some attention to levels, but the Oct-Nov 08 situation proved that oversold is basically useless/harmful if the newsflow is sufficiently bad. Most capitulations center on an event which is too big, too bearish for most investors & traders to ignore, so it flushes out all but the perma-longs. The bigger the impact of the event, the bigger the panic selloff and the bigger the subsequent rally after the capitulation occurs. I therefore think it's better to try to trade capitulation in terms of time rather than price. Wait until it is obvious that the fear is near a climax, and then just start scaling in to deep OTM short-dated calls (to protect you in case the crash deepens...and to get more leverage per unit of risk). You may be a bit early but when the low arrives you will make a crapload of money. Besides, whenever I tried to wait for the exact low, most times I missed it. Whenever I got in 2-3 days early, and scaled in, I caught it by default after initially losing some premium. The only times I've caught the exact low were when I was not actually looking to do so. The best trades come to you rather than you having to force them.
I was talking about capitulation, not oversold levels. The testable elements are a fear climax amongst market participants, along with parabolic price action (i.e. larger and faster than normal price moves). Personally I have found it predictable enough, my capitulation fade trades have a high win rate and good reward to risk ratio and have made substantial net profits over the years.