Oversold / overbought levels

The first interest of oscillators, linked to their tension indicator status, is to mark sensitive levels, forecasting possible reversals. It is for this reason that the “overbought” and “oversold” concepts have been set up. These levels correspond to market excesses. For example, in the case of an overbought situation, the stock rose steadily without consolidating or correcting significantly, thus letting expect a forthcoming reversal. This is expressed by the oscillator at a high level, in a zone, which has been defined as oversold area and which shows the existing tension on the market. This is also the case, symmetrically, on the downside while, between both extremities, the market is considered as neutral.



Still, reading these overbought and oversold zones can be more complex. Indeed, oscillators can take two different forms, with or without boundaries. Indicators with boundaries evolve between two fixed limits (often 0 and 100). It is then easy to determine these zones (for example above 75 for overbought and below 25 for oversold). In comparison, indicators without boundaries, by definition, have no theoretical limits on the upside and on the downside, which makes it more difficult to set up such zones. However, though it is careless to buy in an already overbought market, the sole analysis of the indicator level does not necessarily give all information (see graph).