How To Predict Market Capitulation Days (And How To Profit)

Tyler Durden's picture

The Goldman Markets team has put together this handy analysis on a proposed set of metrics that could be used to spot capitulation days, based on such inputs as VIX, options skew, daily trading volume relative to the 50 DMA, magnitude of sell-off,
return from S&P’s intraday low to close, and the Fama-French winner/loser momentum. Based on the correct spotting of true capitulation days, Goldman predicts that those buying stocks following dramatic sell offs leads to abnormal profits. On the other hand Goldman refuses to mention the alternative: shorting the market on days when stocks, which now have an implied correlation of about 1 and no associated volume, melt up alongside the risk-FX squeeze. Furthermore, there is no accounting of those situations where after a several hundred point drop, the Federal Reserve refuses to get involved, which as Alan Greenspan pointed out, is unlikely, due to the Fed's perception that the market is the one true indicator of economic health (and nothing less than a case of the tail wagging the dog.) Lastly, one should not forget the abysmal track record of Markets' group top 2010 trade recommendations, presented below as of today: with 2 out of 9 top recommendations profitable, clients who have bet against Goldman's sell side advice have made a mint.

Can Capitulation Days Be Predicted?  A Follow-Up

From time to time, we also look at interesting statistical methods to complement our fundamental work.  With investors reading the tea leaves for signs of a market bottom back in early July, we revisit our earlier work from July 2008 that distinguishes between the “true capitulation days” – days that mark the end of downward trend in equities – and days that are just stepping stones to further losses.

Using S&P 500 data back to 1990, the screening process consisted of first isolating the “candidate capitulation days”, which we defined as days when S&P traded more than 5% below its 50-day MA, 5% below prior week’s close and 1% below previous day’s close.  Then, to qualify as a “true capitulation day”, the “candidate capitulation day” had to turn positive the following day, gain at least 1% the following week, and gain at least 3% the following month.  In the end, the above described process filtered out 188 “candidate capitulation days” and 37 “true capitulation days” for us.  The criteria used here to screen for “true capitation days” is obviously arbitrary, but our sensitivity analysis showed little impact on our derived results from varying the parameters.

Secondly, to improve the odds of ex-ante indentifying a “true capitulation day”, we consider six additional factors that may influence the probability of correctly detecting a “true capitulation day”.  Those factors are: 1) the VIX, 2) options skew, 3) daily trading volume relative to its 50d MA, 4) magnitude of sell-off, 5) return from S&P’s intraday low to close, and finally 6) the so-called Fama-French winner/loser momentum.  Thus, conditional on observing a ‘candidate’ capitulation day, these factors were useful in helping us identify whether an event may turn out to be ‘true’, i.e., the market does better thereafter.

In our earlier work, we concluded that the VIX and cross-sectional momentum gave the clearest signals, while trading volume and options skew gave the most mixed results.  But the 2008 experience countered some of those lessons, with the VIX peaking in November ’08, while S&P only bottomed in March of ’09.

New Systematic Approach to Predicting Capitulation Days

To try and create a systematic screening tool for “true capitulation days”, we estimate a simple econometric model using five factors to come up with the likelihood of identifying a “true capitulation day”.  Specifically, we use: 1) the VIX, 2) daily trading volume relative to its 50d MA, 3) return from S&P’s intraday low to close, 4) winner/loser momentum and 5) VIX 2-months - 1-month  time spreads to filter out days, whose characteristics most closely match those of “true capitulation days.”   The goodness of fit of this simple “probit model” is modest (on the order of 30%).  But all the coefficients matter (i.e. they are statistically significant).  The resulting output of this tool is a daily probability from 0% to 100%, where 100% suggests that that a day resembles a “true capitulation day” the most, while 0% suggests it resembles a “true capitulation day” the least.

It Pays To Pay Attention to Market Capitulation: Real-Time Perception vs. Ex-Post Reality

A preliminary look at the predictive power of our tool on subsequent S&P 500 returns provides promising results, which deserve to be studied in more detail along with their significance relative to prevailing volatility in the markets.  We compared the returns across quartiles of our “capitulation probability” metric.  Indeed, the subsequent returns tend to diminish as we move from days marked as “most resembling true capitulation days” to “least” across the spectrum of our probabilities.  In fact, the average 1, 2 & 3-months subsequent returns for the top quartile days (capitulation day probability of at least 75%) are 1.2%, 1.8% and 2.4%.  On the other hand, the average returns for the bottom quartile (capitulation day probability of at most 25%) for the same time horizons are 0%, 0.3% and 0.6%.

A better test of whether these factors capture the market's mood is whether a meaningful concentration of days that closely resemble “true capitulation days” in one month tends to drive the conviction that the market has capitulated?

We simulate this theory using our model by designating days with “capitulation probability” of at least 75% as those with high perception of market capitulation and evenly dividing our sample into two buckets: months with at least 3 and months with fewer than 3 of such days.  Convincingly, the average 1, 2 & 3-months subsequent returns for months with at least 3 days of top quartile capitulation probability were 0.6%, 1.9% and 2.5%.  Conversely, the subsequent returns for months with fewer than 3 top quartile days were 0.3%, 0.2% and 0.9%.  That said, this analysis supports our thesis that paying attention to days, when perception of market capitulation is high (i.e. frequency of what our statistical work identifies as highly probable “true capitulation days” is high), has historically been rewarding.

Lessons for Near-Term Market Dynamics

What do these results suggest for future market direction?  According to our analysis, May and June stood out as months with unusually high frequency of highly probable “true market capitulation days”.  In these months, we have respectively recorded 13 and 7 days with top quartile capitulation probability relative to both historical and past year medians of 3.  But furthermore, May 20th was also flagged as a “true capitulation day” according to our screening process.  We believe that such strong anticipation of capitulation has ultimately helped fuel the relief rally we saw in July.

At the same time, risk premia across assets has been on decline since May.  VIX has halved to 23 vol points since the year-to-date peak of 46 vol points recorded on May 20th.  As Dominic Wilson has recently noted, the compression of risk premia across asset classes has been justified by the fact that that the heightened concerns about sovereign defaults (in Spain in particular) and broad financial systemic risk have been excessive.  As our view on balance remains that systemic risk and asset market volatility are overpriced, this might suggest that overall risk sentiment has bottomed back in May, which in turn could take downward pressure off equities in due course.

In conclusion, despite some arbitrariness in the definition of capitulation, and the model risk around our results, our empirical analysis corroborates a view that the market may be forming a bottom, and if that is the case, volatility could come down further. However and more broadly, a sustained S&P rally beyond the short-term horizon that this research piece has focused on will likely either require better than expected news on US slowing or a more accommodative US policy response, which is extremely constrained in dealing with a slowdown at this juncture.

And for those curious, here is Goldman's top trade track record: 2 out of 7 is pretty damn good... as long as one does the opposite of what Goldman recommends.

  1. Stay short S&P 500 Dec10/Dec11 Forward Starting Variance Swap, opened at 28.20, with a target of 21, now at 30.38. [loss]
  2. Stay long Russian Equities (RDXUSD), opened at 1645.9 for a target of 2050, now at 1631.95. [loss]
  3. Stay long GBP/NZD, opened at 2.29, with a target of 2.60, now at 2.1606. [loss]
  4. Close short 2-yr GBP swap rates vs. long 2yr AUD swap rates on a 1yr forward basis, opened at -268.5 bp, for a potential loss of 24 bp (inclusive of carry). [loss[
  5. Close short 2-yr TRY rates through cross-currency swaps, opened at 8.77%, with a target of 12.0%, for a potential loss of 168 bp (inclusive of carry). [loss]
  6. Close long 5yr credit protection in Spain vs. short 5yr credit protection in Ireland at 13 bp, opened at 70 bp, with a target of 20 bp, for a potential profit of 2.9% (inclusive of carry). [profit]
  7. Stay long the GS FX Growth Current, opened at 103.5, with a target of 111.8, now at 104.45. [profit]
  8. Stay long PLN/JPY, opened at 32.1, with a target of 37.5, now at 28.4298. [loss]
  9. Stay long Chinese Equities (HSCEI), opened at 12616.01 on 01 Apr 2010, with a target of 15000, now at 12140.5. [loss]


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SheepDog-One's picture

WOW the rigged casino passin out cheat sheets? Truely BIZARRE!

French Frog's picture

When the rigged casino is passing out cheat sheets, it must mean that the rules of the games have changed (ie, the cheat sheets are now obsolete and (yet unrevealed) new rules are in play)

SheepDog-One's picture

'To try and create a systemic screening tool...' nice grammar Goldman idiots! Did you guys even get past the 3rd grade before skull and bones indoc course?

Borat's picture

Guess what TD... today is Capitulation Day. Enjoy.

Young's picture

Crude bitchez!

AccreditedEYE's picture

What good is this? We don't have capitulation anymore... that's old school! <sarc>  

old_turk's picture

Sell side school for people who don't mind going to hell for lying douchebags.

And they've got some great deals for condos in Florida too!

RobotTrader's picture

Do or Die for banks


reading's picture



The ISM reported its manufacturing gauge fell to 55.5 in July from 56.2 in June, but that came in better than economists had expected the index. The consensus estimate from Reuters was 54.0. A reading above 50 indicates expansion.

Construction spending rose 0.1 percent in June. The May reading was revised sharply lower to a 1 percent drop from the initial estimate of a 0.2 percent decline.



Glad to see it's all good news cause it could have been worse news? the way, exactly what is the nomical dollar value of a .1% gain in construction spending?

wiskeyrunner's picture

ISM slowest of 2010 market loves this. Listen to the markets. Make free money buy any and all dips till November. We will make new highs.

wiskeyrunner's picture

Yes sir we are going much higher. 11500-12000  on the Dow by November no sweat.

bruiserND's picture

When Tyler and the ZH hit monkeys inevitably turn bullish is the time to sell.

As long as they keep dismissing the rally as a GS conspiracy theory hold on tight.

WiskeyRunner is a smart guy.

wiskeyrunner's picture

This is so easy a cave man can do it......step right up and get your free money, buy long make free money till November. Just buy and wait for the new 52 week high.

Rogerwilco's picture

Six months into a "recovery" and the ISM "falls less than expected", GDP growth is flat line, and mortgage rates are at historic lows.

The markets rally.


PeterSchump's picture

How was everyone's cardinal climax yesterday?

ReallySparky's picture

I am disappointed that it has been a non-event.  I suppose many people are very embarrassed about the fact that nothing happened.  I had thought the market would crash.  However with all the intervention, then I thought that something would have to pop out somewhere else.  Bunch of hoopla over nothing.  A total nothing burger.

firstdivision's picture

1130 will be quite an interesting point IMO.  Should be there in the next 24 to 30 hours.

wiskeyrunner's picture

Turn off the news rookies just listen to what the market is saying, price action is all the matters. Market is not worried right now about economic data, why? Because it's all rigged to the upside till the election. Trust me we will bust thru the April highs by November.


Hold your nose and get long, make this free money right now, while the getting is good.

Dburn's picture

Good attitude WR


Don't fight the tape and get on the house side of the big Con. Bernanke is going to fight like Hell to keep Dems in control becuase 2012 could easily mark the end of his career if he doesn't. The Con is on. Get the inverse of SDS and DXD or buy puts on them. Unload Nov the day before the election. Then capital will be plentiful for an extended capitulation rally. A new Oxxymoron that fits the last ditch fight to stay in control.

wiskeyrunner's picture

That big head & shoulder top on the daily US indexes, has now formed an inverse head & shoulder pattern. We just broke the neck line and will be heading much higher. Pull up a daily line chart of the SP 500 cash.

Mojo's picture

Market Capitulation Days = Buy the Dip

Borat's picture

Tyler, maybe you should consider an analysis of Bovespa index as a leading indicator for this rally. I've been tracking it and there was a serious decouple a couple of weeks ago. Todays rally is not been followed by bovespa. Would it be the new EUR/JPY?

Eric Cartman's picture

Best and brightest!

PatsPal's picture

Uncle. I'm done shorting the market. I gave up on this. Only a fool would listen to the news or zerohedge and go short. You can't fight the Fed. My white flag is flying and I'm joining the bullish party. Sure, we all know the truth but what is truth? It is what the government tells you it is. Taylor, Mish and Denniger may be all correct in philosophy and theory but they sure as hell have been wrong in regards to the markets. So, listen to them and go broke or join the party? Your choice. No body seems to want to stop the corruption anyhow, so might as well be corrupt along with them.

Eric Cartman's picture

Keep a lookout for the potential head and shoulders move to the downside. 

Dburn's picture

ZH isn't a trading service. Your right to go long but don't blame ZH for uncovering the ugly facts. As they say "No matter what accounting system you’re on, eventually you have to meet Jesus"

When that happens you don't want to be long and watch your capital get wiped out.

This place is incredibly refreshing as they seem to be able to keep political bias to a minimum while reporting facts without the stenographer approach of "he says and she says" . The facts accompanied by informed analysis by the various contributors are not only helpful for traders but it’s a canary in a coal mine for people with small businesses who think the worst is past and make Cap-ex expenditures only to find there is no business to support it, now or 12 months from now.

Go to Waxie Parness and pay $2900 a month if you want a trading service.

Watch CNBC for a cheerleading service. Don’t blame ZH for your trading losses.

Eric Cartman's picture

Have him run cnbc for a few days and he'll be sold on the idea to go long and stay long. Then when the market comes crashing, he'll come back here and bitch about it. Let him go buy and hold. lol.

merehuman's picture

There was a time when people were ashamed. There was a time when folks were honest for its own sake. As the market values rise the worth of humans lessens. I am disgusted by all of you willing to trade a dishonest market.

It says a lot about your morality and ethics. 

AccreditedEYE's picture

Not to pick on Merehuman, but has anybody else noticed today's market action is having a massive psychological impact on some of our fellow posters here on ZH? I bring this up simply to point it out... This market wears on everyone. However, some perspective is needed... what are we up with today's highs on the S&P YTD? close to 1%? 

Lux Fiat's picture

Sounds like a capitulation day of a different sort to me. 

I get the concept that as the USD gets trashed, stocks tend to rev as they may represent a "better" store of value - if the USD deteriorates faster than corporate revenue and earnings potential.

However, when the 30 yr yield is rising percentage wise as much as the SP-500 today, this round of QE 2 may result in stocks getting shot in the foot instead of soaring.

Stocks may very well roar into November, but I have to wonder if this is a last weak hand shake-out attempt.  Particularly when GS's sell side says buy the dips.

hellboy's picture

Does anyone still have the PDF to hand which was on ZH some weeks ago with Goldman's top trading ideas? Pretty much what TD put at the end of the article above, but the "official" Goldman pdf version... Thank you very much!


Eric Cartman's picture

Why on earth would you want that?

the grateful unemployed's picture

i still consider the problem from a traders perspective to be the double leveraged (pro) funds, where trading for the next day closes at 4 oclock the day before. In this Uber transparent market, transparent for them, thick as milk for the rest of us, they see which way the next days trade is going, and go against it. The psychology is even simpler, those who open a trade and get hammered, up or down, usually close out the position, once you on the right side of this coin flipping game its pretty easy. of course mondays are good because no one is going to put in a sell order friday afternoon, and then sit around all weekend waiting for war with Iran to happen. so its suckers bet, mostly with two sets of rules, and essentially using the same underlying stock equity futures.

Eric Cartman's picture

Dr. House! Holy crap. I've been trading for a few years now and recently I've been experiencing these flash like symptoms then I pass out on my trading platform and can't remember what I bought or sold. Last night I woke up and blood was coming out my butt... like I'd literally been fucked but all I did was trade stocks. What is wrong with me?

the grateful unemployed's picture

Just about every one of his patients has a sexually transmitted disease, or the possibility, i suggest you check your computer virus program, and double down.

carbonmutant's picture

I wonder if this can be scripted into TOS...


carbonmutant's picture

" Goldman predicts that those buying stocks following dramatic sell offs leads to abnormal profits."

Makes you wonder what they're planning...

scratch_and_sniff's picture

You cant polish a shite, and besides, by the time the average idiot goes through that system he'll need to buy his shoes back from the pawn shop, just to hang himself with the laces.