Knowing the difference between oversold and overbought stocks can help you identify whether it’s the right time to buy or sell your assets.
However, you should also know how you can analyze the trends as well. But what does it mean for an asset to be oversold?
What Does Oversold Mean?
When an asset is classed as oversold, it’s referred to where it’s been traded lower than it’s worth. Because of that, it has the potential for a price bounce.
In some cases, an oversold asset could mean that it has further to fall.
Typically, oversold conditions can last for a long period, so most investors will wait for the price to base out and go higher before they buy it.
Oversold conditions don’t necessarily mean a price rally will start soon. However, there are many technical indicators that can be used to identify any oversold and overbought assets.
These analyze the price and how it is currently trading when compared to previous prices.
How Do You Know If Stock Is Oversold?
You can see the value of oversold stocks by using technical indicators. It’s important to check for oversold stocks to see if there is an expected change in the market.
However, each indicator has a different value of strength than others. So let’s take a look at what are some good indicators to view.
There are two major charting indicators that can tell the conditions of overbought and oversold stocks. These are the relative strength indicator, otherwise referred to as RSI, and stochastics.
Relative Strength Indicator
The RSI is a range-bound oscillator, so it will fluctuate between 0 and 100 depending on security performance. It does this by calculating an assed based on the average gains and loss periods of the asset.
When an RSI approaches 100, it tends to mean that the gains exceed the average losses over that period.
So the higher the level, the stronger a bullish trend is. However, an aggressive downtrend means that the RSI will measure to readings closer to 0.
To understand better, an RSI level of 80 or higher will indicate that an asset is considered overbought, however, an RSI level of 30 or lower indicates an oversold asset.
RSIs are measured through trading days, and the more that they’re used, the more accurate an RSI will become.
Meanwhile, stochastics measure the price level of a current trend, and compare it over a period of time. Stocks that close near their highs when they’re in an uptrend, and near their lows in a downward trend.
So, when the price action moves towards the middle of the range, it usually means that the trend momentum has become exhausted.
If you measure a stochastic value nearer towards a value of 100, then the prices were at their highest during that time frame.
However, if they’re valued at 80 or above, your stock is likely considered overbought. Once you’re looking at a value of 20 or lower, then this would indicate that your stocks are oversold.
However, you would need to measure using both of these, and through a collection of other tools to figure out the best time to buy and sell.
Either way, while these methods are the best way to collect data, that doesn’t mean that it’s the most accurate, as the readings for both may prove to be more premature than expected.
Is Oversold Bearish Or Bullish?
If you’re trying to identify whether oversold conditions are bullish or bearish, then the best way to do so is by using stochastics.
I’ve previously discussed the stochastic readings above, and so it’s best that you also know whether you can interpret the readings as bearish or bullish.
Bearish signals are typically a good time to know if it’s a good time to sell, while bullish is the opposite.
When you look at oversold conditions, they usually are considered bullish, as they can be viewed as an opportune moment to buy.
That’s because many anticipate a rise in price momentum when they appear.
However, that doesn’t mean that you should trade when you see that an asset is oversold. Instead, you should monitor the situation to ensure that the trend remains strong.
Does Oversold Mean Undervalued?
Ultimately, oversold stocks are undervalued. When you see an asset continuously sold on the market, it means that the asset has hit rock bottom.
Usually, this means that there’s going to be a price bounce about to happen.
That’s because investors will look for oversold stocks, so they can buy them cheap and sell them for a high price. However, overbought is the opposite of this scenario.
Should You Buy Oversold Stock?
Some investors mistakenly view oversold stock as a signal to buy the stock immediately. However, an oversold reading is more of an alert.
Typically, it will mean that it’s trading in a lower price range than it usually would be. That does not necessarily mean that the asset should be bought.
There are many stocks that look cheap, but that’s because most oversold readings are viewed via past performances. If there’s a bleak future for any stock or asset, they may be continuously sold off, even if it does look cheap.
As oversold assets can remain oversold for a long period, many seasoned investors will wait to buy it until the price moves higher.
As you can see, understanding the difference between oversold and overbought stocks can help prevent you from getting too many losses on the market.
Oversold assets are typically undervalued assets that sell for a lower price, and many investors are tempted to buy them. That’s because in some circumstances, they can be sold for a higher price.
However, it is wiser to buy them when the price is already going upwards.
By analyzing trends and understanding the strength of each one, you can find out when the best time is to buy or sell your asset.
Once you are certain of your trends, then you should have better opportunities to trade your assets with confidence.