If you’re a technician who is always paying attention to the charts, oversold or overbought stocks probably catch your attention. They’re great setups for a trade.
Many traders hear “overbought” or “oversold” and they panic. No need to. It’s just a warning sign that traders have become too bullish or too bearish on a stock. It doesn’t help when “experts” add to the panic. Some will tell you to run away from the market when overbought conditions stack up. The same expert will tell you to open up your wallet and start buying incessantly when oversold conditions are present.
However, if selling at the top and buying at the bottom were really that easy, everyone would do it. You could get into big trouble if you try to time your moves based on these conditions. Overbought stocks can stay that way for quite awhile. Oversold can too, though this condition tends to last for far less time.
Instead of buying an overbought market and selling an oversold market, you simply need to remain aware of the condition and tread through it carefully. (Here’s an explanation of how to manage an oversold condition.)
Overbought stocks can serve up profits
Some of the most bullish trends are overbought. Recently, a stock called Meta Platforms – maybe you’ve heard of it – reached an overbought condition after rising for five days in a row. The “experts” would have told you to sell the stock. But what did Meta Platforms do AFTER reaching overbought status? It went HIGHER, and kept going up for another 14 consecutive days!
If you ignored the experts, you would have ridden the stock higher by more than 8%, a huge win. So much for an expert opinion.
Remember that strength begets strength. In other words, a strong trend tends to remain strong. When conditions are overbought or oversold, keep your eye on money flows, volume and, of course, price action.
During Meta’s uptrend, I would have told you to trim some of the profits, a risk management move I always advocate for. The best trends barely give you a chance to get in and they rarely tell you when it is over. Better to take some profits when you have them. When the trend turns back down, losses will be big, so pay attention and be ready to bail when the time comes.
