4 Ways to Trade During Capitulation

During market capitulation, stock prices plummet rapidly as widespread selling occurs.

This phase often results in substantial financial losses for investors. For example, in March 2020, the S&P 500 fell by over 30% within a few weeks, erasing billions in market value.

Individual investors who sold at the bottom locked in massive losses, missing the subsequent recovery.

This period also sees increased volatility, with the VIX, a measure of market volatility, often spiking to extreme levels, further complicating investment decisions.

4 Ways to Trade During Capitulation

Identifying Oversold Stocks

Relative Strength Index

One of the most popular tools to identify oversold stocks is RSI, which is typically set at a 14-day period. If a stock RSI is below 30, it typically means that the stock is oversold. For example, if Apple’s stock rapidly drops due to the market overreaction, and the RSI hits 28, it may be an excellent opportunity for a wise investor to buy the stock to profit from the rebound.

Bollinger Bands Strategy

Bollinger Bands help a trader visualize volatility and price levels. If a stock price touches or breaks through the lower band, it may indicate that the stock is potentially oversold. For instance, if you see Tesla’s stock price dipped below the lower Bollinger Band, you can rest assured that now is the best time to enter the position for your profit.

Volume Analysis for Confirmation

Volume is one of the key components when confirming the oversold conditions. If investors observe increasing volume on the days when a stock hits a new low, it may imply that the stock has been capitulated, i.e., most sellers already sold out their stocks, meaning the stock may now rebound. For example, if Netflix’s stock increases to 5 million shares on the same day when its 52-week low is hit, is a clear indication for contrarian traders.

Moving Averages

An easy and applicable approach to confirm that the stock is oversold is applying moving averages like 50-day or 200-day. For example, if a stock significantly sells below its 200-day moving average, but the stock starts curving upwards instead of decreasing continuedly, it means that the selling pressure depreciates. For example, if Amazon’s stock price starts increasing right after plummeting its 200-day moving average, however, it may be an indication that the stock moves from oversold conditions to recovery.

Timing Entry Points

Fibonacci retracement levels are a trader’s best friend when it comes to finding out where and how strong the price is likely to make a turn. It is typically plotted between the most recent price high and low to pin where the market can find support or resistance . For instance, should the price of Google’s stock increase from $1000 to $1500, but then begin to recede, the Fibonacci levels of 23.6%, 38.2%, 61.8%, and 78.6% pinpoint the areas where a trader may want to enter a sell order. Should the value stabilize somewhere around the 61.8% level, approximately $1230 at the beginning, it indicates the strongest point to buy or enter a trade.

Another effective approach is to use the hammer or the bullish engulfing patterns, though there are many others . They provide the clearest signs that the market sentiment will see a turn, and they take place either near support levels as determined through Fibonacci, or in the case of the RSI, when the stock is heading into the oversold territory . Should the Microsoft stock display the hammer at one of the major support levels determined through Fibonacci as it begins to go up from a recent low, it is likely the best buy signal.

Reliability of Moving Average Crossover

Using an average moving crossover is yet another effective way to time one’s market entrance. When some shorter moving average is applied, say, the previous ten days, and it moves up across a longer-term one, frequently 50 days, the stock should be trending up . Should the Amazon, for instance, see its ten-day average start to trend up across its 50-day average when the stock is on the rise from a relatively recent low, it is the best time to buy it. Volume cannot be left out of the picture either. It is always necessary to examine whether it supports one’s decision. Thus, when the Apple stock begins to go up from a low, or perhaps past one technical indicator of its average moving, the significantly higher volume on that day only confirms the legitimacy of the entrance.

Wisdom of Trading Legends

The real key to making money in stocks is not to get scared out of them” was what Peter Lynch used to say. When it comes to timing one’s entrance, it is as true today as it ever was. Following legends who mastered it requires not only applying technical analysis but having the guts to take action when everything else tells you it is wrong.

Setting Stop-Loss Orders

The Average True Range is one of the best tools for putting stop-loss orders. It reflects the volatility of a stock over a specific period, typically 14 days. To ensure that one’s stop-loss is tailor-made to the stock’s current volatility, one may set it at 1.5 times the ATR below the entry price. For instance, if one buys a stock of Nvidia as its ATR is equal to $5, a stop-loss at $7.5 below the purchase price is sufficient to ensure that one may benefit from enough market fluctuation without losing too much.

Using Fixed Percentage Stop-Losses

A fixed percentage is one of the easiest ways to put stop-loss orders. The general rule is to put the order 1-5% below one’s best price, depending on one’s risk tolerance and the stock’s volatility. Facebook purchased at $250 may be sold at $245 in case a 2% stop-loss is implemented. This is a quick way to do it that does not suppose too much math and ensures that everything one loses is a manageable sum.

Putting Stops Around Support or Resistance

It can be wise to put stop-loss orders at the support or resistance levels. For instance, if one has just bought a stock, putting a stop-loss order right below the support line may be a good way of limiting one’s risk. If the stock of Apple is bought at $175 near the support level of $170, setting the stop-loss at $168 may be a decent way of protecting oneself from value going down badly again.

Stopping Out on Unusual Volume

Unusually high selling volume is one of the signs that a particular price drop can be stronger than usual. If one buys Tesla’s stock and it starts falling down with an unusual volume of trading on the market, putting a stop-loss order below the place where volume spiked or much lower may be a good way of stopping one’s losses from escalating.

George Soros stated, “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much money you lose when you’re wrong .

Planning Exit Strategies

Setting target prices is one of the easiest ways to plan exits. Typically, traders come up with these exits based on either a percentage gain, a specific price point, or via chart analysis. To illustrate, if buying a $100 amazon stock and setting a target of $120, it guarantees a 20% gain. This method employs detailed chart analysis and utilizes historical analysis of resistance levels to come up with a realistic and profitable target.

Trailing Stops Strategy

Trailing stops are a very effective way of ensuring profits are locked in while still leaving the room for the stock’s trajectory to keep growing. The stop-adjusts upwards based on the stock’s price point, meaning that if amazon increases its stock from $3000 to $3500, the trailing stop of 5% now becomes $3325.

Technical Indicators in Exiting

The Moving Average Convergence Divergence and Relative Strength Index are great technical indicators of when to exit a stock. For instance, here it could be buying via a rolling window of 5 days with a rolling window of 10 days of the buy.

Time-Based Exits

Traders opt to exit a stock because they have a clear defined time frame it is supposed to be open. As in the case scenario, one could have a tax rate of 15% on capital gains if our shares remain open longer than our acquisition for at least a year. It is clear that this exit was not determination by the market but the personal financial strategy of traders.

It is clear that planning an exit is very crucial after acquiring a stock that one intends to profit from. As Livermore says, “The real money made in a holding on for the ride up and not in frequent trading .” This marries my strategy of a time-based exit over a profit target.

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