Baron Rothschild once said, “Buy when there is blood in the streets, even if the blood is your own”. As traders, we want to be as flexible as possible to take advantage of other people’s misfortune. Trading is a ruthless game and not for the faint of heart, especially when markets are volatile.

Now trying to catch a falling knife can be a dangerous strategy, as it is usually much easier to trade with the current i.e. the trend. However, there are certain moments, rare setups that signal market capitulation. This is where stuck longs simply cannot take any more pain, and it can mark a significant short-term market bottom. 

Such a setup was made in the QQQ’s yesterday, and I sometimes refer to it as the Hand of God or capitulation trade. There was a significant bounce in the market yesterday, could this be a reversal candlestick pattern in the QQQ?

Taking advantage of Panic

The capitulation trade is all about taking advantage of the panic. It is very rare that any large-cap stock will be down more than four days in a row, let alone the entire market as a whole. Last week the QQQ’s were down 4 for days in a row for a 7% move in the red. When I see this type of action, I get ready for a potential bounce trade. 

To spot this type of move, I want to see an acceleration in price met with a massive block of volume, larger than any previous candle. This trade is all about watching volume rather than chart setups. Here is an example on the daily chart from the last couple of months in ALIBABA Group (BABA)

Notice how there were 3-5 down days followed by extreme volume 2-3 times more than the previous days. On these occasions, we see in the following couple of days/weeks there were moves of 10% or more in BABA!

The significant volume is a sign of capitulation as the sellers dump all they can, but this action is met with significant buying, and the stock does not go any lower as supply runs out. This “absorption” by large buyers, who soak up shares I like to call “The Hand of God” as they accumulate these shares and proceed to push prices higher as sellers run out.

We saw a similar hand of God pattern yesterday midday in the QQQ’s but in a slightly different form. The QQQ’s were down over 4% for the day and thus 11% in 5 days. But this day, rather than a single candle, this volume was shared over six 5 minute candles. See Below

A Hand of God is made midday on a basing absorption pattern!

If you add up all the volume at the $335 price level over these candles, that would be a massive volume candle if it were combined into one. This is another way in which absorption can be reflected in a slightly less obvious way. The QQQ’s proceeded to rally over 5% over the next 4 hours, erasing all its losses for the day. This was clearly a “Hand of God” from some very large players who saved the QQQ’s from further selling. Here is what the chart looks like on the Daily:

Daily chart of QQQ’s forming a possible capitulation bottom on Significantly Increased Volume

As we can see, the daily chart setup has formed another “Hand of God” or capitulation setup. Now, these do not always work, and this low may need to be retested or even broken in the coming days, but at the very least, we know that there are significant buyers at these levels! 

Given that the QQQ’s are down over 10% from their highs coming into the Fed meeting over the next 2 days, I would not be surprised to see higher prices over the next week if the market likes what Chairman Powell has to say about future monetary policy and Interest rates.

Bottom Line

The capitulation trade is based on the increased volume in unsustainable moves or at attractive levels where smart money steps in. This is one of my favorite trading setups, but it must be exercised with extreme caution. 

While some participants are panicking and hitting out of their positions or locking in profits from the short side, the “smart money” on the sidelines steps in and hoovers up shares at a perceived bargain price, creating a “Hand of God”. They will buy as much as they can and then usually demand that prices move higher. 

Price may continue higher as participants realize that the panic is over and feel it is safe to get back into the market. 

This played out intraday in the QQQ’s for a 5% move higher yesterday. On the daily chart, if the $355 level in the QQQ’s continues to hold over the next couple of days, we may see higher prices over the next few weeks as the fear subsides!