We recently talked about how to trade during a bullish, overbought market condition. Today, let’s look at its opposite: the oversold market condition.
But first, I want to dispel a myth. Overbought and oversold conditions do not mean PANIC. They are both warning signs that traders have become too bullish or too bearish. And it’s time to proceed with caution.
An oversold market tends to make traders extra nervous, as it is hard to come to grips with the fact the market is going lower. I get that. When you’re in a bullish trend, the hardest thing to admit is the trend is over. Even though we know that the long-term market trend is up and to the right, sometimes stocks become oversold. At this point, they simply cannot move higher.
How to manage an oversold market condition
Oversold markets are tricky. We are trained to buy the dips, but when there is no dip, we slam on the breaks. Who wants to keep losing money over and over again?
My advice may seem difficult to follow, but the best way to manage an oversold market condition is to wait for the selling to stop, or at least slow down.
Some of my best trading opportunities have followed a huge wave of selling. Luckily, oversold conditions do not last for too long.
But … when do you know it’s time to buy? The markets definitely do not tell you when it’s time. But the technicals provide plenty of clues.
Indicators like relative strength, MACD, money flows, and stochastics tell us when the odds are tilted in favor of buying the dip. If they are aligned with price action and volume, you can feel pretty confident it’s time to make a move.
These tools are the lifeblood of technical analysts and allow us to have an objective view of what is really happening. We are never going to time our entry perfectly, so just get back in when the probabilities are high that the market is going to surge.
