Today, you’ll learn what does oversold stock mean.
- What is an oversold stock?
- Stock oversold indicator
- Should I buy oversold stocks?
- How to find oversold stocks?
An oversold stock is a stock that is down for a period of time and is due for a potential bounce at prior support. The support can also be confirmed by technical or fundamental indicators.
The most commonly used technical indicators are the RSI, MACD, and stochastic.
Generally, professionals use RSI to get buy signals when the value is below 30.
However, it does not mean anything unless the stock price is near support.
Strong support is a factor that can move an oversold stock up.
Usually, the stock price tends to bounce right away when it hits a bottom.
The bounce may look like an uncompleted “V” shape, which signals possible buy trades.
Often, possible trades exist when the price is not consolidating.
Consolidation can also be a sign that the stock may continue to fall or takes a break.
The break can be short or long which depends upon the price action.
What Is An Oversold Stock?(Oversold Meaning)
According to Investopedia, an oversold stock refers to assets that traded at lower prices and have the potential to go up or bounce at support. (source)
What does oversold stock mean? Oversold stocks means the price is perceived to be lower than its valuation or technical metrics. The metrics used can be taken from technical indicators or fundamental factors.
Technical indicators are used by traders to find buy trade signals. As there are so many indicators used by individual traders, the signal is subjective.
It is subjective because some traders may see the stock as oversold, yet others may see the stock to fall further.
Oversold to some traders means nothing while for others, it is significant.
It is only considered significant by professionals when the price action quickly bounces away from the support.
The price action is more important than the signals from technical indicators, because
technical indicators to professionals are only used to filter stocks.
Contrary to what is popular online, the signals from technical indicators lag most of the time.
The lag is caused by different indicator configurations, such as setting RSI period to 30 or more.
Generally, a shorter period makes the indicator react faster while a longer period is slower.
Stock Oversold Indicator
The Relative Strength Index (RSI) is the most popular oversold stock indicator. The indicator was introduced by J. Welles Wilder Jr., in his book, in 1978.
Later, a well-known quant Larry Connor introduced the Cumulative RSI which works well for short-term traders.
The period is set to two days and when the value is lower than five the stock is known to be oversold.
More information is available on the strategy page. The post title is, “Best RSI setting for day trading.”
Note: The setting is not actually for day trading because the stock is often sold after the entry date.
Often, when a trading indicator becomes popular, a new indicator will immerge.
The development of new indicators is due to traders that are trying to exploit their competitors.
For example, the Arnaud Legoux Moving Average (ALMA) was introduced in 2009 to help identify oversold stocks that have the potential to move up.
The indicator has less lag which creates buy and sell signals faster than any moving average indicator.
RSI and ALMA are used by advanced traders to catch oversold and momentum stocks.
When RSI is below 30 and the price crosses above ALMA, it triggers a buy signal.
The risk is the difference between the price and the ALMA trend line. When the price breaks below the trend line, the stock could fall.
Should I Buy Oversold Stocks?
Oversold stocks to traders mean there are possible trading opportunities. Technicians and fundamentalists will most likely buy if certain criteria are met.
The criteria often include the calculation of risks and rewards.
The risk to professionals means the amount is lesser than the reward and is often represented by the 1:2 minimum ratio.
When the risk is greater than the minimum, traders will most likely skip oversold stocks.
Fundamentally oversold stocks are also attractive to value investors. It also means the stock is traded below its perceived value. This may present buying opportunities for technicians.
Technicians sometimes follow the fundamentalists through the price action.
The price actions help in predicting where the market will move.
There are only two types of stocks to buy, namely, momentum and oversold stocks.
What does oversold mean in stocks? Oversold stocks are stocks traded at lower prices. The stock may continue to fall which keeps traders alert.
So, oversold stocks do not mean anything unless combined with momentum.
How to find oversold stocks
Technicians find oversold stocks through technical indicators. For advanced traders, the RSI and ALMA are often combined and used.
Buy signal is triggered when oversold stocks develop momentum.
To detect momentum, advance traders use ALMA to know when oversold stocks are about to go up.
For more information, there are many resources that are available online.