Identifying stocks that are overboughtor oversoldcan be an important part of establishing buy and sell points for stocks, exchange-traded funds, options, forex, or commodities. An oversold market is one that has fallen sharply and is expected to bounce higher. On the other hand, an overbought market has risen sharply and is possibly ripe for a decline. Though overbought and oversold charting indicators abound, some are more effective than others.
Key Takeaways
- Overbought and oversold indicators abound, but RSI and stochastics have stood the test of time.
- The relative strength index indicates overbought conditions when it moves towards 80 and oversold conditions when it falls below 30.
- While RSI is computed using average gains and losses, stochastics compares the current price to its range over a given period of time.
- RSI and stochastics are available on most charting applications, and the default setting is 14 periods, which can be days, weeks, or months.
Relative Strength Index
Two of the most common charting indicators of overbought or oversold conditions are relative strength index (RSI) and stochastics. Developed by J. Welles Wilder Jr. and introduced in the 1978 book "New Concepts in Technical Trading Systems," RSI is a measurement of stock price change momentum. RSI is a range-bound oscillator, meaning that its value fluctuates between 0 and 100 depending on the underlying security performance, and iscalculated based on prior periods' average gains versus losses.
When the RSI indicator approaches 100, it suggests that the average gains increasingly exceed the average losses over the established time frame. The higher the RSI, the stronger and more protracted the bullish trend. A long and aggressive downtrend, on the other hand, results in an RSI that progressively moves toward zero.
RSI levels of 80 or above are considered overbought, as this indicates an especially long run of successively higher prices. An RSI level of 30 or below is considered oversold.
As the number of trading periods used in an RSI calculation increases, the indicator is considered to more accurately reflect its measure of relatively strong or weak moves. An RSI setting to use 14 days of data is more compelling than a setting of only seven days. The standard (default) on most charting applications is 14 periods, which can be measured in minutes, days, weeks, months, or even years.
Stochastics
While the relative strength index is calculated based on average gains and losses, stochastics compares the current price level to its range over a given period of time. Stocks tend to close near their highs in an uptrend and near lows in a downtrend. Therefore, price action that moves further from these extremes toward the middle of the range is interpreted as an exhaustion of trend momentum.
A stochastic value of 100 means that prices during the current period closed at the highest price within the established time frame. A stochastic value of 80 or above is considered an indication of an overbought status, with values of 20 or lower indicating oversold status. Like RSI, the default setting for stochastics is 14 periods.
Do You Buy When Overbought or Oversold?
You buy a stock when it has been oversold because it is undervalued and the stock will rally on a price bounce. When a stock is overbought, you sell it straight away because a pullback will occur. The stock is overvalued.
What Are the Signs of an Undervalued Stock?
The signs of an undervalued stock include a P/B ratio lower than 1, a relative strength index (RSI) of 30 and below, and a stochastic oscillator of 20 points or less.
Is Overbought Bullish or Bearish?
An overbought stock is one that is overvalued, which means the outlook is bearish as there will be a pullback on the stock soon, meaning its price will fall as investors start selling.
The Bottom Line
Boththe relative strength index and stochastics have strengths and weaknesses, and the indicators are best used in combination with other tools designed to establish optimal buy and sell points. Lastly, there are times when a stock, commodity, or market can stay overbought or oversold for a considerable time period before a reversal. Therefore, overbought or oversold signals from RSI or stochastics can sometimes prove premature in strong trending markets.
FAQs
Relative Strength Index
What is the best indicator for overbought and oversold? ›
The two most popular indicators for charting overbought and oversold conditions are the relative strength index (RSI) and stochastic oscillator.
What is an indicator that measures overbought and oversold conditions called? ›
The stochastic oscillator, also known as stochastic indicator, is a popular trading indicator that is useful for predicting trend reversals. It also focuses on price momentum and can be used to identify overbought and oversold levels in shares, indices, currencies and many other investment assets.
Which is the most accurate overbought oversold indicator in TradingView? ›
The Relative Strength Index (RSI) is like a fitness tracker for the underlying time series. It measures how overbought or oversold an asset is, which is kinda like saying how tired or energized it is.
What is the signal for overbought oversold? ›
As RSI is a 0 to 100 range-bound indicator, so upper range like 70 to 100 is considered an overbought zone, and 30 to 0 is an oversold zone. RSI moves down when the price falls. When the RSI reading drops below the 30 level, it indicates a substantial decline in price. It is considered an oversold zone.
What are the levels of MACD overbought and oversold? ›
Combining MACD with the Relative Strength Index (RSI)
RSI values range from 0 to 100, with levels marked at 70 and 30 indicating overbought and oversold conditions, respectively.
What is CCI Buy Signal? ›
When the CCI moves above +100, a new, strong uptrend is beginning, signaling a buy. Use trending indicators or other technical analysis methods to confirm signals indicated by the CCI. When the CCI moves below −100, a new, strong downtrend is beginning, signaling a sell. Close the position on CCI rising above −100.
How to find overbought and oversold stocks? ›
Relative Strength Index
A long and aggressive downtrend, on the other hand, results in an RSI that progressively moves toward zero. RSI levels of 80 or above are considered overbought, as this indicates an especially long run of successively higher prices. An RSI level of 30 or below is considered oversold.
What RSI indicators hint that the underlying stock may be overbought? ›
RSI is considered overbought when above 70 and oversold when below 30. These traditional levels can also be adjusted if necessary to better fit the security. For example, if a security is repeatedly reaching the overbought level of 70 you may want to adjust this level to 80.
What is the short term overbought oversold indicator? ›
Overbought and oversold levels are useful for predicting trend reversals. If the stochastic indicator falls from above 80 to below 50, it indicates that the price is moving lower. If the indicator moves from below 20 to above 50, it signals the price is moving higher. Traders also look for divergence.
Which is one of the most accurate trading indicators? The most accurate for trading is the Relative Strength Index. It is considered one of the best momentum indicators for intraday trading. It helps investors identify the shares which are bought and sold in the market.
What is the most powerful indicator in Tradingview? ›
Below, we will explore the top 10 best Indicators used among traders.
- 1 - Moving Average (MA) ...
- 2 - Relative Strength Index (RSI) ...
- 3 - Moving Average Convergence Divergence (MACD) ...
- 4 - Bollinger Bands. ...
- 5 - Volume. ...
- 6 - Stochastic Oscillator. ...
- 7 - Fibonacci Retracement. ...
- 8 - Average True Range (ATR)
Multi-Timeframe RSI Indicator Overview The Multi-Timeframe RSI Indicator is a sophisticated tool designed to provide comprehensive insights into the Relative Strength Index (RSI) across 11 different timeframes simultaneously.
What is the best overbought oversold indicator? ›
Bound momentum indicators are best suited for overbought/oversold analysis. Basically, there are two types of momentum oscillators: bound and unbound.
Is oversold a buy or sell signal? ›
Investors using RSI generally stick to a couple of simple rules. First, low RSI levels, typically below 30 (red line), indicate oversold conditions—generating a potential buy signal. Conversely, high RSI levels, typically above 70 (green line), indicate overbought conditions—generating a potential sell signal.
What is the difference between RSI and CCI? ›
The RSI tracks the speed of price changes to watch for overbought and oversold conditions, while the CCI focuses on normal deviations from an asset's moving average price to spot divergences from normal trend cycles.
Which indicator is good with RSI? ›
Traders often use RSI in conjunction with other indicators, such as moving averages, Bollinger Bands, MACD, Stochastic Oscillator, and Fibonacci retracements, to enhance market analysis and support decision-making.
Should I sell if RSI is overbought? ›
An RSI reading near 100 (the top of the RSI scale) would be greater evidence of overbought conditions (a sell signal), while an RSI reading near 0 (the bottom of the RSI scale) would suggest oversold conditions (a buy signal).
What is the range of RSI overbought and oversold? ›
Relative Strength Index (RSI)
The RSI oscillates between zero and 100. Traditionally the RSI is considered overbought when above 70 and oversold when below 30.
