Overbought Meaning

Key Takeaways

  • Overbought stocks are overvalued. Such a stock is bought or sold at a price greater than its fair value. Therefore, an impending fall in price is highly likely.Technical indicators like Relative Strength Index (RSI) and stochastic oscillator determine whether a stock is overpriced or under-priced. When RSI reads 70 or more, the stock is considered overvalued.When stock prices peak, short-term price hikes come to an end—it is the beginning of a downward trend. Investors often look for overbought stocks to sell high.

Overbought Explained

An overbought asset is overvalued. It is a market environment where all analysis, reports, sentiment, and indicators point towards a stock being priced above its actual market price.

Sometimes, a stock is promoted excessively—claiming high returns. The trending stock attracts more buying than selling. The demand surplus results in a bullish stock price movement. Sometimes, despite the hype, a company’s financial statementsFinancial StatementsFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more fail to show much progress; such stocks are called overbought.

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For overvalued stocks, bullish price movement is seen consistently—can exist for an extended period. But the trend is unrealistic since it is triggered by market sentiments and investor sentiments. The trend is not based on the company’s actual performance.

Eventually, the market will correct itself—at some point in time. And when that happens, there will be a reversal in the trend. When the market corrects itself, the stock price falls to its intrinsic value—shareholders lose money.

Traders can use various technical oscillators to study the pattern of stock price movement—Relative Strength Index (RSI) ans stochastic oscillator. Traders make crucial buying and selling decisions based on those patterns. Traders take either a short or long position to reap maximum benefits from overbought or oversold securities.

How to Identify Overbought with RSI

First, let us understand what RSI is. The Relative Strength Index (RSI) assesses fluctuations in a stock’s current price—it determines whether a particular stock is overvalued or undervalued.

In 1978, J. Welles Wilder Jr. introduced RSI in his New Concepts in Technical Trading Systems. The RSI readings range between 1 and 100. If the value is or exceeds 70, the security is considered overbought. Alternatively, an RSI value of 30 or less indicates an oversold security.

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RSI is a key technical indicator—it alarms traders of a bullish or bearish oscillation in stock prices. It is calculated with the help of average gains and average losses—made by the stock in the recent 14 periods. Thus, it is an effective momentum oscillator.

As the momentum rises—RSI reads 70 or above—there are chances of a trend reversal. Traders see this as a strict ‘no’ for buying. The market can start correcting itself at any moment; stockholders can end up with losses.

Thus, RSI identifies the peak price of a stock—signals shareholders to sell such stocks at this level. This way, traders can amass significant returns before the price pullback.

Examples

In May 2022, several U.S. stocks were overvalued compared to their financial position. The oscillator’s ratings (including RSI14 levels) signaled the selling of the following stocks:

  • Antares Pharma, Inc. (ATRS) has an RSI14 of 78.67.Blueknight Energy Partners L.P. (BKEP) has an RSI14 of 74.31.Biomea Fusion, Inc. (BMEA) has an RSI14 of 70.54.

Let us look at another example.

In May 2022, NRG Energy Inc. (NRG) is trading at $46.67 and has an RSI of 72.76; thus, it is a signal for stockholders to sell NRG stocks.

Overbought vs Oversold

In the stock market, securities don’t always trade at their intrinsic values. They are bought or sold at a comparatively higher or lower price.

Let us understand these concepts in detail with the help of the following differences between oversold and overbought stocks:

This has been a guide to overbought stocks and meaning. We discuss overbought stocks, markets, RSI Indicators, investment strategy & overbought vs. oversold. You can learn more about it from the following articles – .

Overbought is a condition where particular security is overvalued; it is being bought and sold at a price exceeding its fair or intrinsic value. Such a situation arises when a stock is in high demand—purchased aggressively in the stock market.

The overbought stock signifies a bullish price momentum. Despite trading at high prices, the stock price will come down to its fair value—when the market corrects itself. Stockholders suffer losses owing to the price pullback.

The Relative Strength Index (RSI) is the best momentum indicator to detect overbought or oversold stocks. The other commonly used tool is the stochastic oscillator. The RSI analyzes price movements and future possibilities. When the RSI is 30 or lower, it is a sign that the trader should buy the security. At 30, an immediate reversal of the trend is anticipated—the price will bounce owing to market corrections.

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