The first issue is: what defines overbought? The easiest definition is to use a
bounded momentum indicator which has overbought and oversold levels. Examples of
such indicators include the RSI, Stochastics & CCI. When the indicator value
goes above the predetermined overbought value, the security is considered
overbought.
What I mentioned above is the theory. In actual practice, markets in trading ranges can be considered overbought and oversold. Markets in trends are just that - markets in trend. If a market is in an uptrend then it is supposed to go up. Where is the question of being overbought?
Once the trader decides that a market is in an uptrend, overbought levels in an indicator confirm the strength of the trend. if the indicator becomes overbought and prices keep on moving up, the message is: this is a strong trend.
Summary:
The concept of overbought and oversold markets is valid in trading ranges. Once a market is in a trend, overbought indicator readings is actually a confirmation of the trend.
What I mentioned above is the theory. In actual practice, markets in trading ranges can be considered overbought and oversold. Markets in trends are just that - markets in trend. If a market is in an uptrend then it is supposed to go up. Where is the question of being overbought?
Once the trader decides that a market is in an uptrend, overbought levels in an indicator confirm the strength of the trend. if the indicator becomes overbought and prices keep on moving up, the message is: this is a strong trend.
Summary:
The concept of overbought and oversold markets is valid in trading ranges. Once a market is in a trend, overbought indicator readings is actually a confirmation of the trend.
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