No more Oversold Overbought in your trading system

Every trader has experienced this situation - the price suddenly surges against the previous trend or drops from a high area, and all you can do is be swept away by the wave. Oversold Overbought signals have already appeared, but you need to clarify whether this is an opportunity or just market delusion.

Understanding Oversold and Overbought Truly

Oversold Overbought are not just buzzwords; they are real market behavior indicators that show whether buying or selling pressure has gone too far.

Oversold (Heavy Selling) occurs when an asset is sold excessively relative to its current value, causing the price to fall below what is justified. Selling momentum weakens, and buying begins to step in. At this point, traders should avoid just selling more to prevent losses on a position they might regret, and instead look for buying opportunities. Prices tend to slow down and rebound upward.

Overbought (Heavy Buying) occurs when an asset is bought excessively, pushing the price above what is reasonable. Buying momentum halts, and selling pressure prepares to come in. Do not buy more yet, as the price might top out, and instead look for points to sell.

Indicators That Accurately Signal Oversold Overbought

Knowing the market’s current state makes trading decisions easier. There are two main tools used:

RSI - a highly popular indicator

RSI (Relative Strength Index) measures the ratio of upward to downward price movements, calculated with the formula:

RSI = 100 - (100 / 1 + RS)

where RS = average of upward price changes over N days / average of downward price changes over N days.

The resulting number ranges from 0 to 100:

• RSI above 70 = Overbought, indicating prices are bought too much, warning of a potential correction.
• RSI below 30 = Oversold, indicating prices are sold too much, warning of a potential rebound.

A key point to remember - the 70 and 30 thresholds are not strict rules but standard references. Different assets behave differently; adjust to 75/25 or 80/20 as appropriate.

Stochastic Oscillator - another leading indicator

Stochastic indicates where the closing price is within the high-low range over a specified period.

%K = [(Closing Price - Lowest 14 days) / (Highest 14 days - Lowest 14 days)] × 100

%D = 3-day moving average of %K

%K moves between 0-100:

• %K above 80 = Overbought, buying has peaked, beware of a reversal downward.
• %K below 20 = Oversold, selling has peaked, wait for a price rebound.

Trading Oversold Overbought for Real Profits

Seeing signals of Oversold Overbought does not mean you should buy or sell immediately. You need a plan and confirmation.

Level 1 - Mean Reversal ( - Returning to the Mean

The idea is that prices are not always high or low; they tend to revert to the average. This works well when the market is sideways or range-bound.

Steps:

1. Use MA200 to identify the main trend - price above MA = Uptrend, below MA = Downtrend, on MA = Sideways.
2. Wait for the market to enter Overbought/Oversold zones and identify chart patterns, e.g., RSI > 90 or < 10.
3. Enter trades when the price reaches the extreme points: buy at Oversold, sell at Overbought.
4. Exit when the price returns to the main average, e.g., SMA25.

Real example: USDJPY 2H

USDJPY price breaks above MA200 and oscillates in an uptrend, so Oversold is not as deep as Overbought. Adjust RSI to Overbought at 75 and Oversold at 35. Generate buy signals when RSI crosses up from 35 zone, and close position when the price touches MA25.

) Level 2 - Divergence ( - Contradiction

Divergence occurs when the indicator signals differently from the price. For example, the price makes a new high, but RSI does not make a new high. Divergence indicates weakening trend strength. It is more reliable when combined with Oversold Overbought signals.

Steps:

1. Find assets with clear trends )up or down(, then look for reversal signals like Double Tops or Double Bottoms.
2. Observe RSI entering Overbought/Oversold zones but not making new highs/lows with the price )Bullish/Bearish Divergence###.
3. Enter when the price confirms reversal, e.g., crossing MA5.
4. Exit when the new trend stops or another divergence appears.

Real example: WTI 2H

WTI price nearly makes a new low, but RSI does not. This bullish divergence signals a potential reversal. Sell when RSI is oversold and buy when the price breaks above MA25, with stop-loss set at the previous low.

Common Reminders Traders Forget

Oversold Overbought are not standalone buy/sell signals - they must be confirmed with other tools. Combining with trend analysis, support/resistance, volume improves accuracy.

In a strong trending market, Overbought does not necessarily mean sell; prices can go higher. RSI remains high, or Oversold does not necessarily mean buy; prices can continue downward.

Conclusion

Oversold Overbought are arrows on a trader’s bow. Relying on just one arrow can lead to missed opportunities, but integrating systems like Mean Reversal, Divergence, Trend, and Price Action significantly improves accuracy.

Each tool has strengths and limitations. Oversold Overbought signals point directly but require confirmation from other signals before acting—that’s what separates skilled traders from beginners.