Overbought and oversold are two terms that often appear in the analysis of forex trading. These two things are very important to understand because they can define current price conditions and what steps should be taken to deal with them.
However, before discussing more this system in the forex, let's get acquainted with the definitions of the two terms. Overbought is a condition where the price has reached the saturation limit of the increase. This situation is generally preceded by a very significant uptrend movement.
After the price increase is sufficient, traders and investors who previously pushed the price by opening a buy order will close the position to take a profit. At this point, the price is said to be overbought. Below is further information about overbought and oversold.
Because many market participants close long positions and make profit-taking, prices will weaken after going through overbought levels. The more traders and investors who end their buy orders, the price drops that occur after the overbought level has passed will increase.
How to Recognize the Overbought and oversold?
Both overbought and oversold can be known with the help of oscillator indicators which have two extreme standard levels such as RSI (Relative Strength Index) and Stochastic. If you are trading on the Meta Trader platform, these types of indicators can be installed in the following way.
Open the Insert menu then select the Indicators menu and then Oscillators. Then, select RSI or Stochastic, then click OK. RSI and Stochastic can both measure overbought and oversold but through different standard levels. The limit is 70 for overbought and 30 for oversold.
While on Stochastic, the standard is 80 and 20. For example, if you use the RSI, an overbought condition is seen if the indicator chart has risen beyond the 70 levels. Conversely, oversold is confirmed when the RSI chart drops past the 30 levels.
Meanwhile, oversold in a best forex broker is the opposite of overbought. This condition reflects prices that have reached the saturation limit from their decline. Preceded by a sharp downtrend, oversold can occur because previously there was a huge sell-off from traders and investors.
How to Trade With Overbought and oversold
Let's say the price is currently rising fast but the RSI chart is crossing the 70 levels. It means the price is likely to turn down shortly. In this situation, the ideal step to take is to open short positions.
Although the main function is to provide entry signals for users of trend reversal strategies, overbought can also be exploited by traders who follow trends. Usually, overbought is the first signal for a trend follower who is still holding long positions to consider an exit step.
The trader who follows the new trend will open the position and move away for a moment. They will look for other opportunities when there are signs the price will continue the trend. Just like overbought, oversold signals are entry requirements for users of a trend reversal strategy.
The Characteristics
If overbought becomes a sell signal, oversold is functioned as an indication of open buy. If you use the RSI indicator, the signal appears when the indicator chart continues to fall until it passes the level 30. You need to pay attention to it.
At this time, even trend followers will respond by preparing to end the sell positions that they have held. They can also avoid open positions because they are not supported by signals downtrend forwarding. Whatever it is, you are recommended to use the Didimax forex broker.
This professional broker provides the complete service and best quality for traders. You can trade comfortably there and do all your strategies there. It is included to realize everything due to the overbought and oversold condition in forex trading.
