What is Overbought in Trading?
Overbought is a trading term that describes a situation where a particular crypto asset increases in value on account of disproportionately higher purchase activity. Cryptocurrencies rely on market forces to determine prices. All things constant, the price action of an asset reflects its relevance and trajectory.
When an asset is overbought, its price jumps. Typically, a dump follows next as many try to cash on the price hikes. Therefore, an asset has entered an overbought zone when it trades above its supposed peak. The time an asset takes in overbought territory varies depending on multiple factors, but the outcome is usually a significant correction.
How do you know if a crypto asset is overbought or not?
In cryptosphere, some indicators show whether a certain cryptocurrency is overbought. Both technical analysis and fundamental analysis are used to determine whether a certain crypto asset is overbought or not. Fundamental analysis involves a process of evaluating certain related information available to the general public. Such information helps to predict when an overbought asset will deviate from its new trend.
Technical analysis, on the other hand, can also show if a digital asset is overbought when it stops following the trend in an upward movement. Technical analysts use technical indicators to indicate when a particular crypto asset is overbought.
Effective Overbought Indicators for Technical Analysis
There are certain technical indicators that analysts rely on to know and forecast the trend of the market. Such indicators are also helpful in determining when a crypto asset is overbought. Some factors measure overbought levels. These factors include the trade volume of the crypto asset, the recent price, and the trading momentum.
Let’s take a look at some technical analysis formulas that help us know if an asset is overbought. These technical formulae include the relative strength index or RSI for short, the Stochastic, Williams %R, Bollinger bands, and the MACD, which stands for Moving Average Convergence Divergence, among others.
- RSI: The RSI reveals trading speed and price fluctuations by depicting levels on a scale of 0 to 100. When the RSI signals a 70 and above value, the digital asset has reached the oversold region.
- The Stochastic: This formula, on the other hand, tells an overbought level by comparing the current price of the digital asset with its highest and lowest price over a particular period of time. It also uses a scale of 0 to 100, where anything signalling above 80 shows the asset is overvalued, which means it is overbought.
- Williams % R: This indicator helps to evaluate how the current price of the crypto asset compares with the highest price over a particular period technical analysts call a look back. The Williams % R reveals the asset to be overbought when it indicates a value of 20-0.
The Bottom Line
Numerous technical indicators are used to predict if an asset has reached the overbought range. While some traders rely on one, others rely on a combination of two or more. These indicators are useful in analyzing and extracting valuable information on real forces behind price action.