Capitulation on the Upside

A capitulation on the upside is a capitulation of the shorts. Otherwise known as a capitulation top, it happens when those who have been shorting a stock are being squeezed by the advancing price of the stock caused by frenzied buying and extreme optimism to levels that are no longer sustainable. The shorts are losing money as the price moves up, pushed up by buyers who have to own the stock and are willing to pay up for it and the fact that there may not be enough sellers around. Fearful of an ever-increasing price, the sellers become so frightened that the elevation in prices will never cease that they panic and experience enormous pressure to cover their positions and buy back the stock. With a shortage of stock, the price goes even higher, reaching what is known as blow-off top where the price goes way beyond expectations until the buyers become sellers of the stock.

Often capitulation is started by the short sellers panicking to cover. In effect, they take the rally higher. Once they cover their positions and run the stock price up farther, they run out of gas. Then another short seller comes in.

The onset of capitulation is marked by a blow-off. Blow-offs are price action moves of stocks where they explode or dramatically move upward to levels beyond what might be expected. Essentially blow-offs mark inflection points driven by changes in fundamentals. The trader who can remain cool, calm, and collected and follow the price action without picking up the panic of the crowd can take advantage of these situations to short a stock before the blow-off and then prepare to buy the stock back after panic selling forces everything down.