interpretation of overbought / oversold

Discussion in 'Technical Analysis' started by ngchowdhury, Nov 23, 2005.

  1. ngchowdhury

    ngchowdhury New Member

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    Dear Traderji and All members,
    I have a question on overbought/oversold signal.
    It is said if both the stoch goes above 80 ( or goes below 20) then the market is overbought ( or oversold ), and those point are excellent for going short ( or long).
    My question is, most of the time this is true but not always. For example, in day chart, I am seeing market is overbought, but even after that, it doesnt go down, instead go up and stoch remaines overbought. ( see the attachment, both point 1 and 2 are overbought, however afer point 1, price fell down, not same for point2).
    I saw a similar question on this forun, where it is asked to look at momentum indicator like MACD, but those signal are enough slow, by the time it shows indication price changes very much for day trade.
    I follow Yahoo! finance chart
    Thanks
    Nirmalya
     

    Attached Files:

  2. RajK

    RajK Member

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    Overbought/Oversold conditions are signalled by a family of indicators called oscillators when a security has moved too far too fast in a particular direction.

    Overbought indicates a security has run up much more than is usual for the it in a given period of time. Conversely, oversold indicates a security has sold off much more than usual in a given amount of time.

    Stochastics represents the classic overbought/oversold oscillator. Unfortunately, most traders don't understand how to interpret the information it provides. The worst thing you can do is to close your position just because stochastics hits a high or low extreme.

    The best signals come when stochastics makes a lower high (or higher low) divergence and moves in the opposite direction.

    Unfortunately, many techniques for using the stochastic oscillator can produce consistent losses over time. Some analysts have recommended smoothing the data further, or looking for a confirming overbought/oversold ratio prior to selling or buying. Most secondary filters such as overbought/oversold indicators degrade the performance of the stochastic in that one does not take advantage of major trends, getting whipsawed in and out.

    Beauty is in the eye of the beholder. Overbought and oversold is in the mind of the buyer/seller.
     
  3. karthikmarar

    karthikmarar Well-Known Member

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    Nirmalya

    A Stock can remain overbought or oversold for a longtime. One does not short or long just because the stoch goes above 80 or below 20. The confirmation comes when the stochastic moves out of the the overbought or oversold regions. One has to wait for this confirmation. If you check your chart the price did fall after the stoch crossed below 80.
     
  4. nautilus

    nautilus Member

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    Nirmalaya Hi:

    In strongly trending markets I have witnessed some of the most violent market moves when an oscillator indicator is very overbought the market carries on moving up very strongly. The change in value of the oscillator may be from 80 to 85 but the market may move 100 point or more - and vice-versa in strongly oversold markets.

    Since these indicators are constructed so as they oscillate between 0 and 100. It takes a big market price action for an indicator for example to make it move from 80(overbought) to 85(more overbought) - than say from 40 to 80.

    Based on the attached charts I see that you are using multiple oscillators this I think may not be appropriate. I would suggest you use oscillators in conjunction with another indicator - see recent article on Bollinger bands by Traderji.

    Nautilus
     
  5. thomsv

    thomsv New Member

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    Thanks for the info:)
     
  6. ivanboesky

    ivanboesky Active Member

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    First, you have to ascertain whether the market is trending or not... for this, you can use the ADX indicator.
    Oscillators are used only in rangebound markets. In trending markets, these indicators will stop you out very early and you would lose a major part of the move.
     

  7. raj69

    raj69 New Member

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    There ia a formula in METASTOCK to attach colour (green) for OVERSOLD MACD :
    OscP(12,26,E,%) <= -3 AND ROC(OscP(12,26,E,%),5,$) = -Sum(Abs(ROC(OscP(12,26,E,%),1,$)),5)
    Is there a formula for EXPLORER to know that today's CLOSE is not OVERSOLD BUT yesterday's CLOSE is OVERSOLD ? i.e. Yesterday's colour code is green but today's colour code is blue .
     
  8. munchikana

    munchikana Member

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    Hi Nirmalya,
    Senior members of Traderji have already explained in detail about your query. SO far, I could not find any explanation with regard to RSI in this thread. Therefore, I am venturing in to suppliment a line or two from whatever a little I know on RSI. I have read a few books on technical analysis. Almost all these books consistently advise the trader to ignore RSI in overbrought zone when the market is strongly trending in bullish mode. Similarly, RSI is to be ignored in oversold zone when the major trend of the market is strongly bearish. In strongly bullish market you take only one side of RSI indication. That is to purchase a stock in an uptrend when the RSI signalls oversold. In a strongly bearish market you take RSI overbroght signal to short a share which is in a bearish trend. And last but not least, RSI gives best results in a trading market. You buy oversold and sell overbrought. This is my experience with RSI. However, do not always stick to 70 - 30 range to signal overbrough and oversold levels respectively. Sometimes, you may have to adjust or fine tune these overborught and oversold levels in RSI.
    Happy trading. With warm regards
    munchikana
     
  9. sudoku1

    sudoku1 Well-Known Member

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    :thumb:...............
     
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