We use a range of cookies to give you the best possible browsing experience. By continuing to use this website, you agree to our use of cookies.
You can learn more about our cookie policy here, or by following the link at the bottom of any page on our site.

Free Trading Guides
EUR/USD
Mixed
GBP/USD
Mixed
USD/JPY
Bearish
Gold
Bearish
Low
High
of clients are net long.
of clients are net short.
Long Short

Note: Low and High figures are for the trading day.

Data provided by
Oil - US Crude
Mixed
Bitcoin
Mixed
More View more
Real Time News
  • Just a reminder, the White House's deadline on the auto tariff decision is due today after the extension. Stay on Twitter watch. Trump seems to like make big calls shortly after the close...
  • Heads Up:🇳🇿 NZD BusinessNZ Manufacturing PMI (OCT) due at 21:30 GMT (15min), Actual: N/A Expected: N/A Previous: 48.4 https://www.dailyfx.com/economic-calendar#2019-11-14
  • RT @ABehsudi: Commerce is expected to extend a limited, temporary waiver for blacklisted firm Huawei, notwithstanding any last-minute direc…
  • RT @zerohedge: POMO is temporary, they said. It's just a mid-September tax payment, they said https://t.co/nBeHAZ9kJc
  • $MJ: Pot stock market caps going 'up in smoke' https://t.co/q3v88TVO93
  • Indices Update: As of 21:00, these are your best and worst performers based on the London trading schedule: France 40: 0.19% Germany 30: 0.11% US 500: 0.02% Wall Street: 0.01% View the performance of all markets via https://www.dailyfx.com/forex-rates#indices https://t.co/TtF93qmxed
  • Oh, team building exercises. I'm sure that brought Knot and Holzmann around to dropping concerns about diminishing returns on negative rates and extreme monetary policy... https://t.co/5lpgsAJtbC
  • Update on #Cryptocurrencies #BITCOIN -1.15% #BITCOINCASH -2.47% #ETHEREUM -1.87% #RIPPLE -1.87% #LITECOIN -2.84%
  • RT @CNBCnow: BREAKING: The 50 attorneys general investigating Google are preparing to expand their antitrust investigation beyond the compa…
  • remaining operations will include 14-day with $35b offering
Overbought vs. Oversold and What This Means for Traders

Overbought vs. Oversold and What This Means for Traders

2014-04-24 03:02:00
Rob Pasche, Forex Trading Instructor
Share:

Overbought vs Oversold Talking Points:

  • Overbought means an extended price move to the upside; oversold to the downside.
  • When price reaches these extreme levels, a reversal is possible.
  • The Relative Strength Index (RSI) can be used to confirm a reversal.

Like many professions, trading involves a lot of jargon that is difficult to follow by someone new to the industry. It’s our job as instructors to fill in as many knowledge gaps as possible to make the education process as simple as possible. Today, we will take a look at what it means for a currency pair to be overbought or oversold, and most importantly, what trading opportunities arise from these situations.

Overbought vs. Oversold

These two terms actually describe themselves pretty well. Overbought describes a period of time where there has been a significant and consistent upward move in price over a period of time without much pullback. This is clearly defined by a chart showing price movement from the “lower-left to upper-right” like the chart shown below.

Learn Forex: USDJPY Hourly Chart – Overbought

USDJPY price move to the upside for a period of time without much pullback is referred as Overbought

The term Oversold describes a period of time where there has been a significant and consistent downward move in price over a period of time without much pullback. Basically a move from the “upper-left to the lower-right.”

Learn Forex: USDCHF Hourly Chart – Oversold

Extended move to the downside without much pullback is referred to Oversold

Because price cannot move in one direction forever, price will turn around at some point. Currency pairs that are overbought or oversold sometimes have a greater chance of reversing direction, but could remain overbought or oversold for a very long time. So we need to use an oscillator to help us determine when a reversal is actually occurring.

Reading the RSI

There is a quick tool you can use to gauge overbought and oversold levels, the Relative Strength Index. The premise is simple, however. When RSI moves above 70, it is overbought and could lead to a downward move. When RSI moves below 30, it is oversold and could lead to an upward move.

Learn Forex: Relative Strength Index, Overbought and Oversold Levels

Overbought vs. Oversold and What This Means for Traders

But, we must be patient before we enter our trades, because sometimes the RSI can stay overbought or oversold for quite awhile. The worst thing we can do is try to pick a top or a bottom of a strong move that continues to move into further overbought or oversold territory. So we must wait until the RSI crosses back under 70 or crosses back above 30.

Learn Forex: Relative Strength Index, Overbought and Oversold Levels

When to Sell in the Forex market using Relative Strength Index (RSI)

The image above shows the RSI clearly breaking above the 70 level resulting in an overbought reading, but we do not want to immediately sell because we do not know how far price could continue to rally. We want to wait until the RSI falls back below 70 and then place our sell trade. This gives us a better entry and a higher probability trade.

When the RSI falls below 30, same rules apply. We want to wait until the RSI crosses back above 30 before we place a buy trade.

Good trading!

Get started with this Free New to Forex Guide to help you get up to speed on a variety of different approaches for trading.

You Might Also Be Interested in....

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

DISCLOSURES

News & Analysis at your fingertips.