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Overbought and oversold concepts in the analysis of the stock market

Overbought and Oversold

Modern technical Forex analyses often contain concepts of overbought and oversold of financial asset. Overbought and oversold are very relevant concepts, which are often applied both in the prognosis and in the analysis of the stock market. However, it is not enough to just know exactly what they mean. It is worth learning of how particularly they can be applied in trading.

Concepts in the analysis of the stock market

So, overbought is a condition of price of a financial instrument in a certain period of time when growth for some reason is suspended, and the price itself, in relation to its local lows is above all. This can happen, when number of wishing to buy a financial asset is minimal, and the number of those, who wants to sell, is just beginning to grow. This particularly is resulting in reversal of the current trend to the opposite direction.

Oversold is a state of prices, which is the opposite to overbought. It is observed when selling traders achieved all the desired minima and further selling transactions are risky. At this point, the price freezes and begins to collect those, who wants to have a "ride up".

The overbought and oversold areas are usually maximal or minimal points on the market (respectively) in a certain time interval and their extreme points usually coincide with the resistances and supports lines.

The most important thing that influences the price is the market demand and its volume. It is the main prices driver from North to East and vice versa. However, you need to understand that often the market supply and demand affect the price immediately. The price begins to move in those points where it seems unreliable for sellers or buyers in the market. These particular moments are called overbought and oversold prices.

The identification of major turning points in the market brings us to the most important aspect of investing. The fact that major new trends by definition are always formed in extremes. The sooner you take part in the new trend and the stronger it is, the more opportunities you will have for the profit. If you identify an extremum and determine its extent, it also becomes an absolute benchmark for risk options management. In other words, if we think that the large price low was set in the market, and investing money in two weeks after this event, we will know that stop-loss should be set at the level corresponding to the particular low, which was two weeks ago.

All price trends are a reaction to trends that occurred immediately before them. If in terms of time the market extremum turns out to be unusual, it is reasonable to assume that the reaction to it will also last for a long time. When newspapers write about the fact that the quotes dropped to a record low market level, it was supposed to show how bad the situation is.

In fact, this meant the coming of record-buying opportunities. This is a critical aspect of market analysis: if we can set the extremum, we are also able to seal off the degree of expected reactions. For example, record a maximum of 2000 was the end of the 18-year-old "bulls" market. Accordingly, the reaction, or the fluctuation of the price in the opposite direction, should be commensurate with such a long-term increase.

Summing up all aforesaid it is possible to assert with confidence that extreme investing is often the key to market success.

By Chieffinancing 25.07.2016

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