Overbought Oversold for traders looking to avoid buying high and selling low

What is Overbought Oversold?

Many people understand that Overbought Oversold is a technical analysis used to indicate whether an asset is being traded excessively or not. But what does this term really mean in trading?

Simply put, Overbought Oversold measures the balance between buying and selling pressure based on historical price and volume data. It interprets whether the current price is likely to be overbought (Overbought) or oversold (Oversold), helping traders avoid buying at too high a price or selling at too low a price.

Understanding Oversold and Overbought Simply

Oversold (Too much selling) occurs when an asset is sold excessively, causing the price to fall below fair value (too low). At this point, sellers start to weaken, and buyers may step in to support the price. Therefore, oversold conditions often signal a potential reversal upward soon.

Overbought (Too much buying) occurs when an asset is bought excessively, pushing the price above fair value (too high). At this point, buyers may become less willing, and sellers might enter to push the price down. Overbought conditions often indicate a possible correction or pullback in the near future.

Simple principle: Oversold = buy point, Overbought = sell point

Indicators That Help Identify Overbought Oversold

RSI (Relative Strength Index)

RSI is an indicator set between 0-100, measuring the ratio of upward to downward price movements over a period of ‘N’ days (usually 14 days).

Calculated as: RSI = 100 - (100 / (1 + RS))

where RS = average of upward price changes / average of downward price changes.

How to use RSI to find Overbought Oversold:

• RSI > 70 = Overbought signal, indicating the price may be overextended upward, consider selling
• RSI < 30 = Oversold signal, indicating the price may be oversold downward, consider buying

However, note that the values 70 and 30 are not absolute; they can be adjusted based on market conditions. For example, in a strong trending market, RSI > 75 might be used for overbought.

Stochastic Oscillator

Stochastic Oscillator (%K) indicates where the closing price is within the recent high-low range (usually 14 days).

Calculated as: %K = [(Closing Price - Lowest Low 14 days) / (Highest High 14 days - Lowest Low 14 days)] × 100

Using Stochastic to identify Overbought Oversold:

• %K > 80 = Overbought, price has moved out of the high zone
• %K < 20 = Oversold, price has moved out of the low zone

The advantage of Stochastic is that it can detect reversal signals more quickly and clearly than RSI in some cases.

Practical Trading Strategies

( 1. Mean Reversal - Trading in Range-bound Markets

Mean Reversal works best when the market lacks a clear trend, just oscillating sideways.

Trading steps:

1. Use MA200 to identify trend direction
   • Price above MA200 = uptrend (not suitable for Mean Reversal)
   • Price below MA200 = downtrend ###not suitable for Mean Reversal)
   • Price oscillates around MA200 = no clear trend (most suitable!)

2( Set oversold/overbought zones with thresholds like RSI < 10 for buy, RSI > 90 for sell

3. Enter trades when RSI reaches target zones

4( Close positions when price returns to MA25 or SMA5

Example: USDJPY oscillates between MA200 and support levels; RSI at 35 can be a good buy point, indicating a potential reversal upward toward MA25.

) 2. Divergence - Detecting Trend Reversals

Divergence occurs when price and indicator move in opposite directions—price makes new highs/lows while the indicator does not—signaling a possible trend change.

Trading steps:

1. Find assets with a clear trend )uptrend or downtrend)

2### Wait for overbought/oversold conditions combined with conflicting RSI signals, e.g., RSI Double Bottoms while price forms Double Tops

3. When price crosses MA5 = trend reversal signal, consider entering

4( Close the position when the new trend weakens

Example: WTI in a downtrend, RSI enters oversold but does not make lower lows while price does—Bullish Divergence—indicating selling exhaustion. When price crosses above MA25, it’s a buy signal.

Cautions

Overbought Oversold are not foolproof formulas

• RSI > 70 does not mean “must sell immediately”; prices can stay overbought for a long time in a strong uptrend
• In trending markets, Mean Reversion may not work well
• Use as part of a multi-confirmation trading system, not as a single signal

Additional tips:

• Divergence at overbought/oversold zones tends to be more reliable
• Adjust RSI and stochastic parameters to fit your timeframe )Timeframe)
• Find markets, assets, or timeframes suitable for each strategy

Summary

Overbought Oversold are powerful tools to help you avoid buying at the top and selling at the bottom. Their strength depends on proper use, combining with other tools, and understanding market context.

Start by trying Mean Reversal in sideways markets, then gradually incorporate Divergence as you better understand price movements.