Overbought and Oversold: What do These Terms Mean and How to Use Them

Are you trying to figure out what all the stock market terms mean? You don’t have to be a wolf on wall street to understand.

You do need a certain set of vocabulary, though. Some refer to how to buy and sell things, some denote when, and others describe the process.

The Forex trading vocabulary we’re focusing on today? Overbought and oversold stock. They’re similar but different enough to confuse people.

Don’t get confused, learn the difference between these similarly spelled terms below.

Oversold Stock

Imagine something happens with a company that sends social shock waves through investors. Maybe their CEO got caught in a scandal, maybe their products got recalled.

Issues like this cause people to sell their stock, as they’re assuming the worth will drop quickly.

If enough investors sell after a scandal, the mass exodus causes the stock to be oversold.

An oversold stock’s worth is lower than its price.

Depending on the scandal, a stock can be oversold for as little as a weekend to years. A bad oversold rush can obliterate a company’s existence in the market. It’s that powerful.

Should You Buy Oversold?

It depends. Sometimes oversold stock is awesome as an investment since the cost is so low.

If you believe something can recover from whatever made people sell, buy up a bunch at the low price.

However, you never know what a company can bounce back from and what it can’t. If you buy a stock that’s oversold, you could waste your money.

The only way to know if they can recover, and it’s not a perfect science, is to look at other related scandals. How did those companies recover? What does their stock look like today?

It’s always a gamble. To know if a stock is oversold, look at its RSI. An RSI under 30 denotes oversold.

Overbought Stocks

Overbought stocks are the opposite of oversold. If enough excitement builds in the financial community about one company people will buy a lot of stock.

So many people buy that stock, in fact, that there are no more buyers left in the market. In a word, that stock’s buying audience is saturated.

It causes company stock to bounce up quickly, but it generally settles back down.

No stock can move in one direction forever, especially if the spike up or down happened quickly.

To figure out if a stock is overbought, you look at the RSI calculation. An RSI over 70 indicates overbought stock.

Some people who want to buy overbought stock wait until the bounce comes back down. As interest dies down, so will the cost of stock and people will sell.

Once the market is a little roomier, they buy stock then.

Is it a Smart Investment?

Only you can determine how a company’s oversold or overbought stock is going to do. You and your financial planner that is.

Do your research and don’t act too fast, especially in an overbought situation. You’ll end up losing money and regretting buying too high when the price inevitably drops.

For more information on staying ahead of the game try one of these free forex signal providers.

This article was written by our in-house forex traders with a combined 20+ years of experience in trading the financial markets.