Oversold describes a situation in which a security has an inherent value greater than its price, which has decreased due to low demand.
It is hard to determine when a security is oversold, but the Relative Strength Index (RSI), an momentum oscillator developed by Welles Wilder, is one tool that can help make a determination. In the RSI, the average gains and average losses over a specific time period (such as 14 days) are divided to calculate the Relative Strength, then normalized into the Relative Strength Index (RSI), which is range bound between 0 and 100. The RSI typically fluctuates between values of 70 and 30, with higher numbers indicating more momentum. According to this indicator, a security with an RSI under 30 (out of 100) can be considered oversold
The RSI indicator is often used in conjunction with moving averages and stochastics readings to formulate a trade idea. If the RSI indicator dips below 30 and the stochastics and moving average indicators also show a potential bullish trend, the trader may consider taking a long position in the security or exploring call options.
Divergences between the RSI and the underlying index or security may indicate a potential reversal point. For example, if the underlying security is trending down and hits a lower low, but the RSI hits a higher low, it can be considered a bullish divergence.
An RSI score below 30 can be interpreted to mean the security in question is oversold. Where a score of 100 would indicate no negative periods and a score of 0 would indicate no gains during any periods, the basic idea is that somewhere in the middle of all that (around 50) would be the "true" value of a security, and large deviations are indicative of overbought or oversold conditions.
Where a score of 100 would indicate no negative periods and a score of 0 would indicate no gains during any periods, the basic idea is that somewhere in the middle of all that (around 50) would be the "true" value of a security, and deviations too great are indicative of overbought or oversold conditions.
A decrease in demand for a security may be indicative of emotional and social factors rather than economic and financial ones. When the price of a security seems to be less than the "true" value of it, perhaps as indicated by fundamental or technical computations like Relative Strength Index (RSI), the security could be deemed to be "oversold." In this state, the security could be considered a good buy.
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