Yes. Oversold stocks are good. However, one may ask, what is an oversold stock?
The answer depends upon the strategy the trader has. He can use RSI, Stochastic, Statistical Arbitrage and so on.
So, one may ask, how will a trader know if a stock is oversold?
The answer is fair value. How does a trader determine fair value?
Well, people try to answer that question with technical indicators.
For example, Relative Strength Index(RSI) can find oversold levels. One can find it on our site for more information.
From experience, people can use technical indicators to help identify the important levels, but the price is more important because it is the real price move.
The RSI may be at oversold levels but are there commercial buyers right now?
They are the traders who want the stock price to go up. While commercial sellers think that the value is lower.
This is the reason 99% of traders have failed in stock trading.
The illustration below shows that price is more important than technical indicators.
If a trader buys when the price breaks out from the low, he can lose a lot of money. He might be lucky if there is a commercial seller below him.
Therefore, traders should not buy at the break of the low.
Is it a sell trade? Someone may ask, is selling the stock possible because of this information?
Well, it depends if there is a commercial seller above.
This is just an elementary analysis that can help determine if a stock is oversold.
Now, people may ask because of this information, is it an automatic sell?
Well, the answer is definitely no.
What if there is a commercial buyer below?
Well, that is the question that the trader needs to answer. How can he determine if there is a commercial buyer?
Stay Away from the highs and lows
Trading from the highs and lows is never a winning strategy for retail or small traders.
One may think that support and resistance are trade areas, but in reality, it is not. If he has a trading account, that is large enough to move the market, he can trade those areas.
However, retail traders should wait and see if there is a commercial buyer to determine whether the stock is oversold.
It is important to use common sense when trading. People should use what they see in the charts.
Of course, how could someone improve his trading entries when buying an oversold stock?
Well, the price could do something like on the illustration below.
The green area is the most logical place to buy the oversold stock. The level of risk is lower because of the price action.
The commercial buyer has revealed himself. This time, the trader can use technical indicators(RSI) to help him know the strength of this move.
Of course, he can also use other tools that are more reliable.
Price action trading is staying away from the highs and lows for the retail traders.
Macro/Micro Price Action
Consider that the price action above happened in the daily time frame.
Where is the best buy entry in the green area?
Well, one has to use lower time-frames because the market is fractal. The concept is the same with all charts.
This post is already long. And the plan is to teach people the basics of actual trading only.
One should improve upon this core concept which he needs to understand.
Again, traders should stay away from the highs and lows, unless they can move the market.
Trade what you see
After taking the buy trade and setting take profits and stop loss, can the trader relax already?
Well, it is a big no.
People should understand that the trade is not done yet. They should watch for a commercial seller if they bought the market.
That is the reason professional traders move their stops to break even after the price has moved up.
These tools can help determine whether a stock is oversold.
Relative strength index(RSI)
When the RSI is below 30%, it is considered as oversold. (source)
However, one should follow what he sees on the charts.
On this website, it is recommended to use the two period RSI on the daily charts.
However, market conditions may change. Traders need to backtest their trading strategies.
That is why people should trade what they see.
This method is important to banks because they gave liquidity to the markets. The marker makers usually trade with the spreads between the commercial buyers and sellers.
A trader should graduate from elementary trading to college trading. He should understand how to calculate the spread between two or more securities.
Basic trading can make someone money, but he has lesser risk when he knows how to hedge.
From actual trading, yes, oversold stocks are excellent under certain conditions. It depends upon the current price actions.
One should always ask if there are commercial buyers even though technical indicators indicate that the stock is oversold. He should be on guard for commercial sellers.