Overbought Stocks
Overbought Stocks is a list of the most overbought stocks today based on the RSI momentum technical indicator. Overbought stocks are worth watching for traders because the trend for overbought stocks may reverse.
12/1/2023
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What does overbought stock mean?
When a stock is overbought, that means it is overvalued. The definition of an overbought stock differs between investors and traders.
For a long term investor who focuses on fundamental analysis, an overvalued stock's PE ratio is too high, or the growth rate is too low.
For a short term trader who uses technical analysis, an overbought stock means the price of the stock rises too fast, and the trend may be reversed any time now.
Since our tools are based on technical analysis, we defined overbought stock as a trader. We use a technical indicator called the RSI to measure when a stock is overbought.
When the technical indicator RSI is above 70, a stock is considered an overbought stock. When the RSI indicator drops from 70, it generates a bearish signal. The most overbought stocks today listed above are based on the RSI indicator.
How to trade overbought stocks?
There are various ways to find stocks that are overbought using different types of technical indicators, RSI is one of the popular ones. Let's take a look at an example, TSLA.
- The RSI for TSLA went above 70 briefly in late March and the beginning of April, which means the stock is overbought at that level.
- A few days later, the MACD crossed down, which is another bearish signal
- TSLA then went down from around $1,150 in April to a low of $620 by the end of May.
The overbought signal works perfectly for this trade.
Overbought stock example
Here's another example of an overbought stock, SES, where the RSI indicator is over 70.
- The RSI for SES went above 70 and crossed down in late March. If you base your trade on the overbought signal, when the RSI crosses down 70 is when you go short on the stock, or to sell if you already have a long position.
- A few days later, the MACD crossed down, which is another bearish signal. It gives you a second chance to get out of this trade in case you were long on this stock.
- SES then went down from over $10 per share to a new low of $3.61 in less than 3 months.
Multiple technical indicators
In both of the above examples, we use an indicator called the MACD crosstown for confirmation on a stock. It is dangerous to rely solely on the RSI overbought signal.
Traders are free to use any other technical indicators for a confirmation signal. They can also use the overbought stock as a secondary signal to confirm with any primary indicator they use.
Why is stop loss important?
Please remember just because a stock is in the overbought zone doesn't necessarily mean it is a SELL. Some strong stocks may keep going up for a long time before they reach their peak.
During that time, the RSI will stay above 70 and the stock will remain overbought. It is not a good idea to sell or short a stock just because the RSI indicator indicates it is an overbought stock. You should combine the overbought signals with other technical indicators and the general trend of the market.
Therefore, if we use RSI above 70 as a bearish signal and short a stock based on this indicator, we need to have a tight stop loss in the case when we are wrong.
Price Stop - The stop loss could be a price stop-loss meaning if a stock keeps going up and hits a certain price, we would cut our losses and cover the trade.
Time Stop - Whenever we are in a trade using the overbought signal, we expect the trade to work in our favor quickly. If it does not, we need to cover the trade to protect ourselves from losses. You can set a time stop for a week or two depending on your strategy and comfortable level.
Let's take a look at the following example where the overbought stock gives us a false signal.
- As we can see from the above chart for the stock MYE, the RSI indicator went above 70 in late March.
- A few days later, the MACD crossed down, which is another bearish signal.
- However, the stock price of MYE kept going up from around $21 to $25. That is why we should use a stop loss. A few of these failed trades might crush our portfolio if we stay in the trade without cutting losses.
To learn more about trading, read Swing Trading Strategies.
How to find overbought stocks
The stocks that you find on this overbought stocks list are based on the RSI indicator. If you prefer to use the stochastic oscillator for overbought stocks, you can use our free technical stock screener.
- Go to https://stock-screener.org/
- Scroll down to the Technical Analysis Screener
- Check the box next to Stochastic Crossover
- Set the stochastic between 80 & 100 - any stock with the stochastic oscillator over 80 is considered overbought.
Final Words
As with any other indicator, the overbought signal doesn't always work. As a trader, we should always cut our losses quickly if we are shorting a stock based on the overbought indicator.
Always keep in mind that technical analysis is an art, and not a science. One plus one does not always equal two in trading. It is also recommended that you combine the overbought indicator with other technical indicators, such as support & resistance levels, trendlines, candlestick patterns, or the MACD.
One should also backtest his strategy against historical data and see how well the strategy works. The best thing to do would be to study a lot of charts, and see if you can find patterns when the overbought pattern works the best.
The only way that you can trade for the long term is to first survive. Professional traders always cut their losses small which is the opposite of what beginners are doing. They let their losses run and cut profits too soon.
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