3 Reasons To Buy Oversold Stocks

Today, you’ll learn should I buy oversold stocks.

Including:

  • Rise higher within weeks
  • Cheaper to buy
  • Easy to spot
  • Caveat

Traders are better off buying oversold stocks because it can rise within weeks, cheaper to buy and it is easy to spot.

It is cheaper because the price is low relative to its previous prices.

Previous prices can be the the last seven to ten trading days.

The last seven days low is called LR7 while the last 10 days is called LR10.

The LR7 is widely used by systems traders because it is the lowest close price in the last seven days.

The lowest close creates a buy signal if the close is above the 200-moving average indicator.

A 200-average indicator only filters stocks that are still trending up.

When buying, an up-trending stock is recommended by most professional traders.

Professionals would not buy fast falling stocks because falling stocks are like falling knives.

It could hurt anyone who tries to buy it.

Buying stocks requires an understanding of an oversold stock in an uptrend market.

Sometimes, an oversold stock can be detected by using the RSI indicator. However, instead of RSI, LR10 is our main focus in this post.

1. Rise Higher Within Weeks

Oversold stocks can rise within weeks because more traders may buy it if the close is near support.

The support may be significant enough for technicians and fundamentals.

Fundamentals may buy the stock if they sense value in an oversold stock.

In timing trades, oversold stocks allow traders to pinpoint their exact entries.

Traders can be technicians who saw pull-backs from strong trending stocks.

A strong trending stock may close lower than its previous 10-day low because of a temporary breather.

The breather happens because of partial profit taking by traders.

Profit-taking of stocks above the MA200 is still considered to be strong stocks.

Unless the stock price drops below MA200, the trend is still considered intact.

It is still in tack because most long-term investors are still holding the stock.

When investors hold theirs stocks, the stock will continue to rise which invites more traders to buy more.

More traders will buy which makes an oversold stock rise faster.

Stocks will also rise faster because of the short sale restriction.

To elaborate, short sale restriction allows only short-selling when there is an uptick.

An uptick means when a buyer bought the stock at the Ask price which is often higher than the bid.

More buyers may appear when there is an oversold stock which are only hitting the Ask price.

Hitting the Ask price makes short sellers cover their positions because they are having difficulty moving the price down.

When traders are having difficulty trading, they will often close their positions to avoid losing more money.

If the short-sellers are closing their positions, the price will rise faster than anyone can imagine.

2. Cheaper To Buy

Oversold stocks are cheaper because they are traded below their true value. (source)

Their true value is higher based on technical or fundamental indicators.

Some examples of technical indicators are RSI, MACD, and LR10.

An RSI below 30 is often considered oversold when the stock price is near or at strong support.

With strong support, the value might be higher which allows traders to buy the stock.

However, this opportunity should be taken with prudence.

Prudence means setting up stop loss area to reduce the risk.

It is risky because oversold stocks are falling stocks.

Falling stocks looks cheaper but are also dangerous because these stocks may continue to fall.

Stocks will continue to fall unless the volume is also decreasing.

A decrease in volume may mean that the downward pressure is already slowing down. It is slowing down because the selling starts to fade.

If the sellout is starting to fade, that is the moment when traders can actually buy the stock.

Novice traders often buy stocks when their indicators show an oversold signal, which is wrong.

It is wrong because they are actually buying stocks that are still expensive.

Buying stocks that are still expensive is not an example of a high probability trade.

To find high probability trades, traders should look at oversold stocks with volume slowing down and are near support.

Low trading volume indicates that there is no more liquidity at lower prices.

When there is low liquidity, trading algorithms can detect it and they will start driving the price up because it is cheaper.

3. Easy To Spot

Oversold stocks are easy to find because traders can use the RSI and other technical indicators.

In this post, the technical indicator we will use is the LR10. The LR10 is the lowest close price within the 10-day trading period.

In a 10-day period, Amibroker can scan stocks with lowest prices.

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The lowest price is at support which is a possible buy signal.

Buy signal is a high probability trade if the volume is also slowing down. Contrary to what is popular online, high volume at this price is a sign that the stock is still falling.

Falling stocks are not easy to buy because people are still selling these stocks.

Caveat

Oversold stocks to traders is not really an automatic buy trade. It is not automatic because the stocks are still on the way down.

Stocks like these are difficult to buy when these stocks are way before reaching support.

The support must be significant enough for traders to come in and buy the stock.