Overbought is a word used to describe a situation in which a security is thought to be trading at a price that is higher than its inherent or fair worth. A security’s price being overbought generally refers to recent or short-term volatility in the price of the security, and it indicates that the market expects the price to correct itself shortly. This view is frequently formed as a result of the technical study of the security’s price history, although fundamental analysis can also be used to form this belief. A stock that has been overbought may be an excellent candidate for a sell-side opportunity.
Crypto trading: What does it mean by overbought?
To be considered overbought, a cryptocurrency’s price would have to rise without any underlying investment rationale to justify the increase. Following an extreme overbought condition, a selling period is usually followed by a period of consolidation. In layman’s terms, this means that when investors believe that a cryptocurrency asset is trading above its fair value, the asset has entered the overbought territory.
It can last from a few days to weeks, and the price can plummet if the effect reverses. One of the tools used in the digital currency ecosystem to determine if an asset is overbought and when the trend is likely to reverse is technical analysis.
Determining overbought cryptocurrencies
A momentum indicator called the Relative Strength Index (RSI) is used to measure how much the price of a stock or other asset has changed over the last few days and uses that information to assess whether prices are becoming overbought or oversold.
Technical indicators such as traded volume, recent price, and trading momentum are employed to measure overbought levels. For example, technical formulas such as the relative strength index (RSI), stochastic, and Williams % R are used to indicate an overbought state. To help improve trading speed and reduce price fluctuations, RSI factors in trading speed and price fluctuations. Values between 0 and 100 are recorded, with anything above 70 representing an overbought signal.
Concerning the stochastic, the current asset price is compared to its highest and lowest prices over a given period, which results in an overbought state. An assessment of 80 is used to indicate that the asset is overvalued. On the other hand, the Williams % R looks at the current price and how it compares to the highest price over a certain period, also known as lookback. An overbought level is indicated by a value of 20-0.