A Selling Climax day, or Capitulation day, is one in which a down move ends suddenly after the stock in question has been trending downwards for some time (usually days or weeks). These days are good days to start looking for an opportunity to go long (buy) simple because the sudden capitulation or sell off uses up all the force behind the downward move and the downward trend just stops. In other words, all the selling that should take place has taken place and no one is willing to sell below the price at which the sell off stops.
Identifying A Selling Climax/Capitulation
In order to identify a selling climax day, just run a screen looking for stocks or ETFs that closed lower and whose volume has increased by at least 20% compared with the days before and after. The increased volume on the down move is an indication of heavy selling by large holders and this usually forces other smaller players to "cough up" the shares they own. After a while, the bigger players will come back in and start buying in an effort to take advantage of the re-pricing and lower valuation.
Generating The Buy Signal
After you spot the 20% + increase in volume on the down move , you have to wait for a re-test of the low of the selling climax day. However, the volume must decrease by at least 8% on a re-test of the low and the price must close above the low of the selling climax day. The lower volume re-test is usually an indication that the sellers have truly stepped aside and a close above the lows confirms that the market may be about to turn. Simply put, a decrease in volume on the re-test and a close above the lows will be your buy signal.
We usually, use this set up and trigger to buy At The Money Call Options and use the previous high as the profit target as that will form an area of resistance in most cases. This is a strategy that is not hard to implement and can work about 68% of the time if done properly.
The key is to ensure that you wait for a re-test of the selling climax low. A common mistake is to jump in on the day after the the Selling Climax even though the absolute low has not been re-tested. You can usually capture a few upside points by jumping in the day after but the real money will be made after the re-test and close above the low because it will usually trigger an upside trend that can last for many days or even weeks. So a little patience is needed here.