Profiting from the Oversold point is a skill that traders need to know

Oversold is a condition where an asset has been sold excessively, causing the price to fall below its true value. Conversely, Overbought is the opposite condition, where the price has risen beyond its realistic level. Both conditions are smart signals that help traders avoid making mistakes, such as selling too cheaply or buying at too high a price.

First, Profit Comes from Avoiding Overbought and Oversold

Signals of Oversold and Overbought do not occur simultaneously with weather changes but are derived from technical analysis based on historical price and volume data. Recognizing the difference between these two states will help you make precise decisions.

Oversold (excessive selling)

• Price has dropped to a level where it is already reboundable
• Indicates that selling pressure is about to diminish and buying will come in
• Price tends to pause and reverse upward (Rebound)
• Analyzed with indicators like Stochastic below 20 or RSI below 30

Overbought (excessive buying)

• Price has surged too high, exhausting the momentum
• Indicates that buying pressure is about to end and selling will take over
• Price tends to retrace and decline (Pullback)
• Analyzed with indicators like Stochastic above 80 or RSI above 70

RSI and Stochastic: Essential Tools for Reading Oversold

RSI (Relative Strength Index) - Momentum indicator

RSI measures the strength ratio of price movements, calculated as:

RSI = 100 - (100 / (1 + RS))

where RS = average of up days’ prices over N days / average of down days’ prices over N days.

RSI ranges from 0-100, and usage:

• RSI > 70: Overbought condition; consider selling or halting buying
• RSI < 30: Oversold condition; consider buying or halting selling

Tip: The 70 and 30 thresholds are standard but can be adjusted based on asset behavior.

Stochastic Oscillator - Price position indicator

Stochastic checks where the closing price is within the highest-high and lowest-low over 14 days.

%K = [(Closing Price – Lowest Low 14 days) / (Highest High 14 days – Lowest Low 14 days)] x 100

%D = 3-day moving average of %K

%K ranges from 0-100, with usage:

• %K > 80: Overbought; price has exhausted upward momentum
• %K < 20: Oversold; price may bounce back

How to Trade with Oversold: Use Mean Reversion Effectively

Mean Reversion is a strategy that plays in sideways markets (Sideway), assuming that overly high or low prices will revert to the mean.

Steps to trade Mean Reversal with RSI:

1. Check the trend with MA200 - If the price is above MA200, it indicates a clear uptrend
2. Identify Oversold points - Wait for RSI to enter Overbought or Oversold zones as set
3. Enter the trade - When the price hits the identified point
4. Exit the position - When the price re-enters the MA25 or MA200 line

Real example USDJPY (2H) USDJPY price stays above the MA200 line, indicating an uptrend. RSI is oversold at 35. To buy, wait until RSI drops to 35, then buy and close the position when the price reaches the MA25. This avoids buying at overbought levels in an uptrend.

Divergence: Trading Reversal Points

Divergence occurs when an indicator (such as RSI) signals a contradiction to the price movement.

Examples:

• Price makes lower lows (Lower Low) but RSI does not follow with lower lows, instead higher lows (Higher Low) — Bullish Divergence = buy signal
• Price makes higher highs (Higher High) but RSI does not follow with higher highs, instead lower highs (Lower High) — Bearish Divergence = sell signal

Steps to trade divergence:

1. Identify assets with a clear prior trend (up or down)
2. Observe RSI signaling divergence (Divergence)
3. Enter when the price confirms the new trend, e.g., crossing MA5 upward
4. Exit when the new trend weakens

Real example WTI (2H) WTI makes a new low, but RSI shows Bullish Divergence, indicating selling pressure is exhausted. When the price breaks above MA25, buy with a stop-loss at the previous low.

Summary: Oversold is a Signal, Not a Guarantee of Profit

Oversold and Overbought are powerful tools to avoid poor decisions, but they do not guarantee profits by themselves. The key is to combine them with other indicators like Moving Averages or Patterns to confirm signals. Once confirmed, consider combining Oversold signals with other tools and always keep risk management in mind during trading.