Overbought and Oversold are terms used to describe when conditions are right for a stock price to change direction. Oversold is the belief the stock price has increased to the point where it has become exhausted and may not increase very much more without a pullback (PB). In contrast, Oversold is the belief a stock price has decreased to the point it will most likely attract buyers and therefore is expected to change direction for a price increase.
There are many different Overbought and Oversold indicators. At Investor’s Yak we recommend using only one or two indicators to avoid waiting on a group of indicators to synchronize with one another. While there is such an indicator specifically called the Overbought/Oversold Indicator (OB/OS), many other indicators also convey this information. For example many oscillators swing (or oscillate) up and down. When they reach an 80% threshold or higher, they are considered overbought. Similarly, when they fall to a 20% threshold or lower, they are considered oversold. Here are some examples of Overbought and Oversold indicators presently available today:
Indicators for Overbought (Extended in Price)/Oversold (Reduced or Diminished in Price):
- Stochastic Oscillator
- Moving Average Convergence/Divergence
- Relative Strength Index (RSI)
- Commodity Channel Index (CCI)