Capitulation refers to a period of strong selling activity, where investors give up their positions and sell their holdings as quickly as possible. It is often referred to as panic selling because during a period of capitulation, sell orders peak at a much higher-than-average level, which quickly drives the asset price lower and lower until a bottom is eventually reached.
Capitulation can be described as the moment when investors lose hope - accepting losses and giving up their previous gains. When the panic selling period is over, marking the end of the capitulation, it may be followed by either a consolidating period (sideways price movements) or by an upward trend that would potentially indicate the beginning of a bull market.
The reason why capitulation periods often lead to price reversal and strong upward trends is that these episodes are usually marked by FUD and panic, so the selling pressure goes beyond normal levels, reaching oversold conditions. The more violent and abrupt the price drop is, the higher is the chance that it will be followed by a strong bounce.
Originally, the word capitulation was used by militaries, referring to the act of surrendering a territory or troop when negotiating terms with an enemy army. When used in a financial sense, the term refers to the moment when investors surrender to prevailing market forces. So instead of hodling in expectation of a market recovery or bounce, investors choose to dispose of their holdings at the currently available market price (market orders are often used during periods of panic selling).
When the market presents an abnormally high volume of sell orders in a short period and a rapid price decline, it may indicate that capitulation is taking place. Although not always easy to predict, when capitulation occurs, it is quickly recognized as it places extreme downward pressure on market prices - with sharp and quick movements.
Capitulations are also part of the cryptocurrency markets and, in fact, are often stronger and faster than the ones of traditional markets. A clear example of this can be seen in the sudden price drop of Bitcoin in January 2015.
A sustained bear market through 2014 led to a period of severe FUD at the beginning of 2015. Investors began to panic-sell their holdings, fearful of incurring even greater losses. The capitulation occurred on January 15th, 2015 - when a massive spike in sell orders over a short period resulted in Bitcoin’s price dropping about 38% in 2 days.
In this example, the bottom was reached around $167, recording an 85.5% decline from the 2013 top (roughly $1153) and the end of capitulation marked the beginning of a bull market. The following day had a spike just as strong as the preceding drop, recording a 38% increase in one day.
Capitulations are more likely to happen and are more easily identified in smaller markets, which present higher rates of volatility. Keep in mind, however, that they do not always lead to a bull market, and should not be seen as an indication of future performance.