{"id":4978,"date":"2020-07-16T18:41:53","date_gmt":"2020-07-16T15:41:53","guid":{"rendered":"https:\/\/roboforex.com/blog\/?p=4978"},"modified":"2026-05-26T10:57:29","modified_gmt":"2026-05-26T07:57:29","slug":"how-to-trade-overbought-and-oversold-areas","status":"publish","type":"post","link":"https:\/\/roboforex.com/blog\/blog\/2020\/07\/16\/how-to-trade-overbought-and-oversold-areas\/","title":{"rendered":"How to Trade Overbought and Oversold Areas?"},"content":{"rendered":"\n

In this review, we will discuss trading overbought and oversold areas<\/strong>. A trader may use special indicators<\/a> that analyze the dynamics of price changes and show the overbought and oversold areas.<\/p>\n\n\n\n

<\/span>What are overbought and oversold areas?<\/span><\/h2>\n\n\n\n
The notions \"overbought\" and \"oversold areas\" in financial markets indicate short-term fluctuations of the instrument values from the average. These terms say that the price has gone quite far in a certain direction. An overbought state of the market means that the price of a financial instrument has gone too high, while the oversold state means it is too low<\/strong>.<\/p>\n\n\n\n
An overbought state is a significant increase in the price (in percent) in a short time or a lengthy series of several days in an uptrend. For example, oil price may become overbought if it leaps by 10-15% during two or three days or demonstrates pullback-free growth for several days.<\/p>\n\n\n\n
As a result of being overbought, the price forms new local highs on the chart. After the bulls<\/a> have pushed the price rather high, making the asset overbought, a correction downwards may follow at any moment.<\/p>\n\n\n\n
When an instrument is oversold, local lows form on the chart. This means the bears<\/a> have pushed the rate rather low, and an upward correction may start at any moment.<\/p>\n\n\n\n
Specially designed trading indicators<\/a> may help the trader catch the overbought or oversold state of some asset. For this, an indicator has its window split in two areas: the overbought and oversold areas. Getting into those zones, indicators characterize the current financial situation of the instrument (whether it is overbought or oversold) and give certain trading signals<\/a>.<\/p>\n\n\n\n
<\/span>Popular indicators for trading in the overbought and oversold areas<\/span><\/h2>\n\n\n\n
Presently, there exist plenty of indicators that help define the overbought and oversold areas. Let us discuss briefly three of the most popular indicators (built in many trading platforms):<\/p>\n\n\n\n
<\/span>Stochastic Oscillator<\/span><\/h3>\n\n\n\n
The creator and greatest fan of this indicator is a popular stock trader George Lane. The Stochastic<\/a> is an oscillator that demonstrates the current position of the price in % of the previous price range<\/strong>. The Stochastic evaluates the ability of the bulls and bears to close the price at the achieved extremes.<\/p>\n\n\n\n
The Stochastic Oscillator<\/a> is drawn in a separate window under the price chart and consists of two main lines: %K, the fast line, and %D, the slow line. The indicator values vary from 0 to 100%; through the levels of 20 and 80%, signal lines are drawn, singling out the oversold (0-20%) and overbought (80-100%) areas.<\/p>\n\n\n\n
$\"Oversold$ <\/a>
Oversold and overbought areas - Stochastic Oscillator<\/figcaption><\/figure>\n\n\n\n
<\/span>Relative Strength Index (RSI)<\/span><\/h3>\n\n\n\n
This index pertains to the group of oscillators<\/a>. It was created and propelled by J. Welles Wilder. The RSI<\/a> assesses the position and dynamics of the current price related to the preceding period<\/strong>. The RSI is calculated in a separate window under the price chart.<\/p>\n\n\n\n
The RSI<\/a> has three signal levels: 30, 50, and 70. The area above 70 is called the overbought area, where you should sell. The area below 30 is the oversold area, where you should buy. If there is a prominent directed trend in the market, use signals<\/a> along with the trend only.<\/p>\n\n\n\n
$\"Oversold$ <\/a>
Oversold and overbought areas - RSI<\/figcaption><\/figure>\n\n\n\n
<\/span>DeMarker<\/span><\/h3>\n\n\n\n
The DeMarker indicator<\/a> was created by an expert in stock trading (and a creator of many other indicators) Thomas DeMark. The peculiarity of the indicator is its paying attention not to closing prices (as many other oscillators) but midterm highs and lows<\/strong>. The calculation method consists of comparing the current highs and lows to the extremes of the preceding period.<\/p>\n\n\n\n
DeMarker<\/a> is calculated in a separate window under the price chart and consists of one main line which fluctuates within the range of 0 and 1. The area above 0.7 is called overbought where the price may form a reversal downwards. The area below 0.3 is called oversold where you might buy.<\/p>\n\n\n\n
$\"Oversold$ <\/a>
Oversold and overbought areas - DeMarker<\/figcaption><\/figure>\n\n\n\n
<\/span>The strategy of trading the overbought and oversold areas<\/span><\/h2>\n\n\n\n
The strategy of trading the overbought and oversold areas seems simple at first glance: sell in the overbought area and buy in the oversold one. However, there is one thing to account for: the current trend. Indeed, the general rule of tech analysis<\/a> is: trade the trend<\/a>.<\/p>\n\n\n\n
If the market is in a range<\/a>, you may trade overbought and oversold areas in either direction. However, if an up- or downtrend is pronounced, better trade the trend.<\/p>\n\n\n\n
Nonetheless, most often, signals in the areas appear to counter the trend, and it is up to you completely whether to trade them or not. As for me, I prefer to wait for a correction and trade the trend.<\/p>\n\n\n\n
<\/span>Buying in the oversold area<\/span><\/h3>\n\n\n\n
Look for signals to buy in an uptrend or a flat. If there is a clear uptrend, wait for the beginning of a downwards correction. Wait for the indicator (Stochastic, RSI, DeMarker, or any other) to enter the oversold area and start reversing upwards; on the chart, a local low will form.<\/p>\n\n\n\n
Open a buying position. Place a Stop Loss<\/a> behind the formed local low. The first goal for the Take Profit<\/a> will be the previous high on the chart; if it is broken away, the quotations may grow further.<\/p>\n\n\n\n
$\"Oversold$ <\/a>
Oversold and overbought areas - Buy<\/figcaption><\/figure>\n\n\n\n
<\/span>Selling in the overbought area<\/span><\/h3>\n\n\n\n
Trade signals to sell in a downtrend or a flat. The course of action is as above:<\/p>\n\n\n\n
\n
Wait for the price to correct upwards in the current downtrend.<\/li>\n\n\n\n
Get the signal of the indicator (Stochastic, RSI, DeMarker, etc.) in the overbought area. On the price chart, a local high will form.<\/li>\n\n\n\n
Open a selling trade with an SL behind the formed local high and the TP - at the previous low on the price chart.<\/li>\n<\/ul>\n\n\n\n
$\"Oversold$ <\/a>
Oversold and overbought areas - Sell<\/figcaption><\/figure>\n\n\n\n
<\/span>Bottom line<\/span><\/h2>\n\n\n\n
Trading the overbought and oversold areas is quite popular among traders. There are plenty of indicators and original trading strategies<\/a> by famous traders meant for detecting those areas.<\/p>\n\n\n\n
To my mind, such trading is most efficient combined with tech analysis<\/a> when you choose trades thoroughly, mostly along with the current trend.<\/p>\n\n\n\n
\n Open Trading Account<\/a><\/p>\n\n\n\n