The share market is a highly unpredictable and volatile place. Every investor is looking for an edge in the market to make the best stock picks. Knowing when a stock is overbought or oversold is one such advantage that can give investors a big advantage.
In this article, we will try to understand the fundamental differences between overbought and oversold states in the share market and provide some tips and best practices to help traders as they navigate the share market.
1. What Is Overbought in the Share Market?
The basic definition of overbought in the share market is when a stock has risen too quickly and the market does not have enough buyers to afford the high prices that result from the increased demand. This concept is associated with the law of supply and demand, which states that when the demand of any asset is greater than its supply, the price will rise.
This can be seen in the share market where the prices of certain stocks can shoot up rapidly due to high demand.
Therefore, if the share market is seeing a rapid influx of buyers for a particular stock, such as a stock whose price is going up steadily for a long period of time in a short span of days, then it can be said for sure that the stock is overbought, and it is important that investors take heed of such notes of caution.
However, it is important to note that overbought stocks don’t always have to crash or correct. The prices can even sometimes rise further. But the key is to understand the underlying dynamics driving the stock’s prices and identify whether it is a sustainable price rise or it is just a speculation spree.
2. What Is Oversold in the Share Market?
The definition of oversold in the share market is the exact opposite of overbought. When a stock has fallen too quickly in price and the market does not have enough sellers to satisfy the market supply, a stock can be said to be oversold. Similarly, when the demand of any asset is less than its supply, the price goes down.
Therefore, if a particular stock, which was previously showing a steady uptrend, is now showing a sudden drop in its price, then it can be said for sure that the stock is oversold and investors should pay special attention to such stocks. It is worth noting that like overbought stocks, oversold stocks don’t almost always go lower. But the underlying fundamentals should always be monitored to ascertain the direction of the stock prices.
3. Tips for Identifying Overbought or Oversold Shares
Identifying overbought or oversold stocks requires careful observation and constant vigilance of the movements of the share market. Investors should keep an eye out for any sudden spikes or drops in stock prices in order to identify any signs of overbought or oversold stocks.
Technical indicators like the RSI or the Relative Strength Indicator can also be used to measure overbought and oversold states, as the values above 70 indicate an overbought area and values below 30 an oversold area. Similarly, investors can also check the volume of buying and selling activity and identify any irregular spikes to obtain further details.
It is important to note that the best way to make informed decisions in the share market is to take a longer-term view rather than trying to make a quick profit out of any situation. Overbought or oversold situations usually don’t last for long and investors should instead focus on investing in quality stocks at reasonable prices which can yield excellent returns in the long run.
Given the high volatility of the share market, it is essential that investors have a clear understanding of the concept of overbought and oversold stocks. Knowing when a stock is overbought or oversold can be a major advantage for any investor in the share market, as this knowledge can be used to make valuable and well-informed stock decisions. Armed with this knowledge, investors can identify the right opportunities in the share market and make the most out of their investments.