Overbought/Oversold: Don't be afraid — a buy/sell indicator that helps you avoid overpriced and undervalued prices.

When it comes to trading, investors often face the same problems: buying at too high a price and selling at too low a price. This time, let’s understand a tool that can help solve this issue — Overbought and Oversold conditions, which are key signals in technical analysis.

Understanding Overbought and Oversold — Two Signals in One

Oversold and Overbought may sound similar, but their meanings and impacts on trading are completely opposite. Both are indicators that tell you whether the current price is excessively low or high based on historical price and volume data.

These indicators rely on the same principle: prices tend to move too far up or down before they recover (Mean Reversion). Traders who understand this can profit by “buying the dip” when prices are oversold and “selling the rally” when prices are overbought.

Why is an Oversold Condition a Buying Opportunity?

Oversold occurs when an asset has been sold off excessively, pushing the price below its fair value. This massive selling often results from fear or panic among investors.

When the market enters oversold:

• Selling pressure begins to weaken (fewer sellers)
• Buying interest starts to emerge (buyers waiting to buy at low prices)
• Prices tend to rebound

Therefore, when you see oversold conditions, consider it an opportunity to accumulate assets at a good price, rather than a signal to sell.

Overbought and the Wisdom of Selling

Conversely, Overbought is when an asset has been bought excessively, pushing the price above its fair value. This strong buying often stems from excitement or FOMO (Fear of Missing Out).

In overbought conditions:

• Buying momentum wanes (fewer new buyers)
• Sellers start to take profits (holders wanting to lock in gains)
• Prices tend to decline

This signals “be cautious, the rally may be exhausted” rather than “buy now.” Smart traders avoid buying in overbought zones and prepare to sell instead.

RSI and Stochastic — Must-Know Overbought Indicators for Thai Traders

Relative Strength Index (RSI)

RSI is one of the most popular tools for measuring overbought and oversold levels. It calculates the ratio of upward to downward price movements over a period.

RSI formula: $$\text{RSI} = 100 - \frac{100}{1 + RS}$$

Where RS is the average gain divided by the average loss over 14 periods.

RSI outputs a value between 0 and 100:

• RSI > 70 = Overbought (price may be too high)
• RSI < 30 = Oversold (price may be too low)

Note: In highly volatile markets like Bitcoin, some traders use >75 or <25 thresholds.

Stochastic Oscillator

Stochastic measures where the closing price sits within its recent high-low range:

• %K formula: $$%K = \frac{\text{Close} - \text{Low (14)}}{\text{High (14)} - \text{Low (14)}} \times 100$$

• %D is the 3-period moving average of %K.

Interpretation:

• %K > 80 = Overbought
• %K < 20 = Oversold

Stochastic reacts faster than RSI, providing quicker signals but also more false positives in trending markets.

Divergence — When Overbought Doesn’t Mean Sell Immediately

To master overbought/oversold, you must understand divergence — when indicators show signals opposite to price action.

Example:

• Price makes a Higher High, but RSI makes a Lower High → Bearish Divergence, indicating weakening buying momentum despite rising prices.
• Price makes a Lower Low, but RSI makes a Higher Low → Bullish Divergence, signaling potential trend reversal to the upside.

Divergence is most effective when combined with overbought/oversold signals.

Trading Divergence Steps:

1. Identify a clear trend (up or down).
2. Check if RSI or Stochastic enters overbought/oversold zones.
3. Look for divergence patterns.
4. Confirm with other signals (e.g., price crossing MA, break of support/resistance).
5. Enter trades aligned with the emerging trend.

Example (WTI 2-hour chart): Oil price makes a lower low in the morning, but RSI shows a higher low — bullish divergence. When price breaks above MA25, it’s a buy signal with a stop loss at the previous low.

Mean Reversion in Range-Bound Markets — Your Overbought/Oversold Weapon

Mean Reversion strategies exploit overbought/oversold conditions in sideways markets without a clear trend, aiming to profit from price oscillations around the average.

Trading steps with RSI:

1. Confirm sideways market with MA200 (price not trending).
2. Set overbought at RSI > 75 and oversold at RSI < 35 (adjusted for weak markets).
3. Buy when RSI enters oversold.
4. Sell when RSI reaches overbought.
5. Exit when price returns to MA25 or MA5.

Example (USDJPY 2-hour): After breaking MA200, price pulls back to test it multiple times, indicating a strong uptrend. When RSI hits oversold, it’s a good buy zone, not overbought.

Beware — 3 Cases Where Overbought Fails

No indicator is perfect. Watch out for these scenarios where overbought signals may mislead:

1. Strong Trending Markets:
In a powerful uptrend, RSI can stay above 70 for extended periods. This isn’t necessarily overbought; the trend is strong. Selling prematurely can lead to losses.

2. Major News Events:
Earnings reports, central bank decisions, or geopolitical news can instantly invalidate overbought/oversold signals.

3. Relying on a Single Indicator:
Use multiple tools (Volume, MACD, Moving Averages) for confirmation. RSI or Stochastic alone may give false signals.

Summary — Overbought Is Not the Enemy, But Your Ally

Overbought and Oversold are tools that help traders “buy low, sell high” by indicating where the market may be overextended.

However:

• Overbought doesn’t always mean “sell now,” especially in strong trends.
• Oversold doesn’t always mean “buy now,” especially in weak or trending markets.
• Combining divergence analysis with overbought/oversold signals improves accuracy.
• Always confirm with other indicators and strategies.

When used with understanding and discipline, overbought/oversold conditions become powerful weapons for precise and profitable trading.