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Getting to Know the Overbought and Oversold Concepts

8:03 AM Jun 25, 2021
5507
Forex trading

Is it good to buy an oversold stock? Of course, it sounds great. However, sometimes the difference between an overbought and oversold asset in the Forex market is not so obvious. That's why professional traders should be well-versed in these concepts, as they directly impact your profit.

Learning to use these indicators will help you increase your profits. You’ll have a chance to detect an imminent market reversal and open a trade at the very beginning of a new trend.

Difference in Concepts

Let's start with a brief description of these two terms:

  1. Overbought is the state of the market after a significant stable growth, ready for a downward reversal.
  2. Oversold, on the other hand, occurs in the market after a significant fall, and an upward reversal is expected soon.

These two concepts show who is currently dominating the market. At the moment of overbought, the bulls are the leading force. The chart is steadily moving upwards. When the market is oversold, bears prevail. They sell steadily and the chart tends to move downwards.

Under any extreme conditions in the market, there is a high probability of a change in the traders’ mood. That is why overbought and oversold conditions give a reversal signal. However, market behavior cannot be predicted with 100% certainty. It is best to use this signal in conjunction with others.

Overbought and oversold data can be found in the RSI indicator. It is a basic free program built into the MetaTrader 4 trading platform. How to use it, read below.

Oversold Market

The RSI indicator is easy to use. You will see an additional curve below the chart that will fluctuate mostly between the 30 and 70 levels. A drop below 30 indicates that the market is oversold, as seen in the picture below.

At the same moment, the chart reached the main support level. The oversold situation in the market signals a further price reversal. Now is the time to go long and enjoy the show.

However, remember that the market does not follow the signals. It works the other way around. It is best to confirm the signal with other signals:

  • Formation of reversal candlestick patterns
  • Bouncing up from the support level
  • Reversal signals of the main trend, etc.

Overbought Market

This condition is a mirror image of an oversold situation. At such times, the market is dominated by bulls and that is confirmed by the persistently growing chart. That’s when you refer to the RSI indicator. When the curve rises above 70, the bears are ready to take the lead and turn the market down.

Still, it’s better to wait for confirmation by other signals. Make sure the chart is in the area of ​​the main resistance line. Wait until the level is broken to the downside and the market closes at least one bearish candle. If there is also a confirming candlestick pattern on the chart at this time, you can safely open a short trade.

These are the main differences between the overbought and oversold concepts. Pretty easy, huh? In the next article, I'll show you how to best apply this knowledge to trading. See you next time!

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terms Stop Loss news trading economical calendar major news release currency pair currency rate national currency trading journal trades profit/loss emotions news release positions size Expert Advisors platform trading robot cryptocurrency volatility day trading position size lot account types cent accounts Mini account ECN Copytrade ECN accounts swap-free minimum deposit order execution liquidity providers demo accounts real account low-risk trading EUR/USD economic calendar majors cross-currencies exotic currencies base currency quote currency quotes bid ask Brexit United Kingdom European Union GBP Euro GDP WTO price levels moving average 4-hour chart 1-hour chart bulls bears false breakout cross-currency USD price action pin bar trading inside bar trading hands off breakeven stop loss 50% stop loss pin bar high-frequency trading position trading swings breakout strategy trading style Entry order Take Profit hammer shooting star inside bar pinocchio bar head and shoulders harami risk 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bottom triple bottom double top triple top pattern signal presidential cycle Elliott wave Kondratiev wave Forex terminology quote standard lot mini-lot micro-lot cross pairs exotic pairs counter-currency terminology Margin Call long position short position buy sell candlestick chart bar chart line chart range market channel high low ADX OHLC patterns profit level martingale aggressive EAs VPS demo account EA tester trading signal chasing the market clicking the button oil trading lot EUR cent account Forex mentor novice trader emotions control fear psychological level round numbers Key Levels indicator MetaQuotes iOS Android mobile trading mobile terminal VPS server financial portals day trader position closing short timeframe fast trading news site news portal FXStreet Investing.com Forex Factory ForexLive DailyFX CPI PPI economic indicators Non-Farm Payrolls monetary policy FOMC retail sales inflation rates program installation intuition apps ECN brokers market makers financial 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losing streak perfectionism consistent profits starting capital initial investment market psychology japanese candlesticks PAMM trust management money manager holidays market sentiment CHF CAD Great Britain pound Swiss Frank reserve currency averaging morning routine initial capital potential profit reverse pattern rounded bottom rounded top saucer inverse saucer IB Program IB Commission Sharing reversal patterns deposits payment methods payment systems local transactions trader’s block market balance