From theory to real trading: Overbought Oversold is the key that cannot be missing

If you still trade based solely on feelings and instincts, it’s recommended to learn about Overbought Oversold first. This is a tool that helps you systematically avoid buying at too high a price or selling at too low a price.

The True Meaning of Overbought Oversold

Overbought Oversold is a technical analysis indicator that measures whether the current price has been bought or sold excessively compared to historical price and volume data. When the indicator signals that the price has entered this zone, it suggests a potential (Reversal) may occur.

Simply put:

• Oversold = Too cheap, too many sellers, buying might be profitable
• Overbought = Too expensive, too many buyers, selling might be profitable

Oversold Condition: When the Market Sells in a Panic

Oversold occurs when selling pressure drives the price below its fair level excessively. Usually, when entering this state, selling momentum begins to weaken, and buyers start to step in to “buy cheap,” causing the price to rebound.

Detection of Oversold uses oscillators such as:

• RSI below 30 = Strong Oversold signal
• Stochastic Oscillator (%K) below 20 = Oversold signal

If you see these signals, don’t rush to sell, as the price may already be too low. It’s better to look for buying opportunities.

Overbought Condition: When the Market Buys in FOMO

Contrary to Oversold, Overbought occurs when buying pressure is excessive, pushing prices higher than they should be. During this phase, buying momentum begins to weaken, and selling pressure increases, leading to a potential correction or reversal.

Detection of Overbought uses oscillators such as:

• RSI above 70 = Overbought signal
• Stochastic Oscillator (%K) above 80 = Strong Overbought signal

At this point, avoid buying more, as the price may be too high. It’s better to look for selling opportunities.

Get to Know Important Indicators

RSI (Relative Strength Index): Strength indicator

RSI measures the ratio of upward to downward price movements over a specified period. The formula is:

RSI = 100 - (100 / (1 + RS))

where RS = average gain / average loss (usually over 14 days)

RSI values range from 0-100, indicating:

• RSI > 70 = Overbought (warning)
• RSI < 30 = Oversold (buying opportunity)
• RSI 30-70 = Neutral zone (normal)

The advantage of RSI is ease of use, but remember it’s only a warning indicator, not a definitive buy/sell signal.

Stochastic Oscillator: Measures price position

Stochastic Oscillator (%K) indicates where the close price (Close Price) is relative to the High-Low range over a specified period, calculated as:

%K = [(Close - Low 14 days) / (High 14 days - Low 14 days)] × 100

%D = 3-day moving average of %K

%K ranges from 0-100:

• %K > 80 = Overbought (warning)
• %K < 20 = Oversold (opportunity)

Stochastic is particularly good at identifying reversal points more accurately than RSI in some cases.

2 Serious Overbought Oversold Trading Strategies

1. Mean Reversal: Trade when prices oscillate within a range

Mean Reversal assumes that the high and low are temporary events, and prices will return to the “middle” level soon. This strategy works best when the market is moving sideways (Sideway), not during strong trends.

Steps for Mean Reversal Trading:

1. Use MA200 to check trend:

   • Price above MA200 = Uptrend
   • Price below MA200 = Downtrend
   • Price near MA200 = Sideway (Ideal for Mean Reversal)

2. Set RSI thresholds according to trend:

   • In an uptrend: Overbought at 75 instead of 70, Oversold at 35 instead of 30
   • Because uptrends rarely become oversold deeply

3. Enter trades at extreme points:

   • Uptrend: Buy when RSI hits Oversold (35) and rises
   • Downtrend: Sell when RSI hits Overbought (75) and falls

4. Close position when price returns to MA25 (short-term middle)

Real example USDJPY (Timeframe 2H):

• Price oscillates above MA200
• RSI enters oversold zone (below 35) = buy signal
• Price rebounds toward MA25 = close sell position
• Profit from the reversal

2. Divergence: Trade trend reversal points

Divergence occurs when the price makes a Higher High / Lower Low, but RSI makes a Lower High / Higher Low. This indicates the trend may be ending or reversing.

Divergence works best when Overbought/Oversold conditions occur simultaneously.

Steps for Divergence Trading:

1. Find assets with clear trend (uptrend or downtrend) showing signs of reversal

   • e.g., Double Top, Double Bottom, Head & Shoulders

2. Check if RSI signals opposite to price:

   • Bullish Divergence: Price makes Lower Low, RSI makes Higher Low (uptrend)
   • Bearish Divergence: Price makes Higher High, RSI makes Lower High (downtrend)

3. Wait for confirmation from break of resistance/support lines

   • e.g., crossing MA5 as entry point

4. Close when the new trend weakens or opposite divergence appears

Real example WTI (Timeframe 2H):

• Price continues downward, making Lower Lows
• RSI enters oversold and starts making Higher Low (Bullish Divergence)
• Enter buy when price breaks above MA25
• Set Stop Loss at previous Low
• Target trend reversal for profit

Adjusting for Different Trader Personalities

A key point many overlook: RSI 70/30 or Stochastic 80/20 are just default values commonly used, but may not suit all assets.

• Strong trending markets: raise Overbought threshold (RSI 80-90), as prices can extend further
• Sideways markets: use standard 70/30
• Highly volatile crypto trading: consider 60/40 instead, due to higher volatility

Most importantly: Don’t rely solely on Overbought Oversold

Overbought Oversold helps you: ✓ Avoid buying at too high a price ✓ Avoid selling at too low a price ✓ Capture correction opportunities

But it’s not a perfect buy/sell signal. Prices can stay overbought longer and keep rising, or oversold longer and keep falling.

How to improve: Combine Overbought Oversold with:

• Support/Resistance levels (Support/Resistance)
• Trend Lines or Moving Averages
• Volume (Trading volume)
• Divergence for stronger reversal signals

Using multiple tools together yields more reliable signals.

Summary

Overbought Oversold is an important tool but not the ultimate solution. Use it in conjunction with other analysis methods, and you’ll see significantly better results. Trading is not based on feelings but on systematic analysis.