Wall Street is full of old saws. There is one for just about every occasion, including when it’s finally time to take advantage of this current bear market and buy.
And one you’re going to hear over and over soon is “stock market capitulation.”
Let’s talk about one of the most hotly debated phrases on Wall Street – one people want to see at the end of bear markets…
What Is Stock Market Capitulation?
Capitulation is the final selling in a bear market where even the most ardent bulls give up.
“Just get me out!”
We can tell when the market experiences capitulation because prices of just about every stock tumble together on soaring volume.
It’s essentially a stampede through the exit doors, and as you can imagine, those exit doors are not wide enough to let everyone through at the same time.
Prices drop quickly and they drop hard as supply swamps demand.
But just because everyone has given up on the market does not necessarily mean it is time to buy. Stocks can languish at low levels for weeks and months before a new bull market can begin. That’s why we call it capitulation. People have simply given up on stocks. They’ve given up trying to pick the bottom or trying to buy at a discount. They are out.
Still, capitulation is usually necessary for a bear market to end. It creates the environment where the market can lick its wounds, rest for a while, and then, when few people are looking, start to pull itself back up.
Of course, the question you’re now asking is whether we’ve seen capitulation yet.
Here’s what to make of it.
What Comes Next for Stocks
After a 30% decline in the market since just Feb. 19, it sure looks tempting to buy what appear to be cheap stocks. After all, if you had your eye on a stock when it was trading at $50 per share, wouldn’t it look special at a price of $35?
And if it is time to buy, do we – here come a few expressions – nibble or back up the truck? In other words, even if we think that it is time to buy, do we start with small purchases, or do we fill up our portfolios in one fell swoop?
The most important thing is to not confuse low-priced with cheap. Low prices can go even lower, and some companies have those low prices because they will not come out of this bear market alive. Their businesses will be decimated and never regain their customers.
With that in mind, there are several ways to plan your next move, including the most dangerous one of saying that stocks are cheap enough to buy, buy, buy. That’s the proverbial “backing up the truck.” Timing the end of a bear market, let alone one that had volatility for the record books, is a dangerous game.
What we want to see is more days like Tuesday, when stocks rallied across the board and with heavy volume. Of course, an 11% rally like we saw in the Dow Jones Industrial Average is probably not going to happen again, but a steady inflow on money back into the market would go a long way to establishing a true bottom.
One other way to go is to take smaller bites in a market that has already shown capitulation but has not really established any sort of bullish trend.
For example, if you buy a little now, don’t be surprised if your stocks fall some more before actually bottoming. But because you only committed a small portion of your capital, you have plenty in reserve to buy more stocks at even lower prices.
And if the market goes right up after you buy, then you will at least have a foot in the door for the next bull market. You can then add to your positions as the rally progresses.
Money Morning Capital Wave Strategist Shah Gilani suggests such a method of easing back into the market. In fact, it involves “dollar-cost averaging,” meaning you might buy some stocks too soon and others a little bit after the bottom, but your overall portfolio will likely be centered close the actual bottom.
And you will be very happy a year or two down the road.
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Source: Money Morning