Investing in Philippines: Investing word of the day: Overbought


Saturday, April 2, 2011

Investing word of the day: Overbought

You may have read this word in all stock analysis or forum and probably wonder what it is.

Here is a definition I pulled out from

1. A situation in which the demand for a certain asset unjustifiably pushes the price of an underlying asset to levels that do not support the fundamentals.

2. In technical analysis, this term describes a situation in which the price of a security has risen to such a degree - usually on high volume - that an oscillator has reached its upper bound. This is generally interpreted as a sign that the price of the asset is becoming overvalued and may experience a pullback.
When a stock is in demand, as evidenced by the growth in volume, prices tend to rise to balance the demand-supply dynamics. In times that the demand for such a stock rises abruptly  supported by a sudden increase in volume and rise in price, the stock is said to have reached its upper level thus it is said to be overbought and the tendency is for those sellers to sell their holdings to take profit. 

This is seen in the the Stochastic indicator when the line breaches the 80 level mark. If the stock is overbought it will soon drop and this alerts holders of such stock to sell to profit from their holdings once it crosses down the 80 level mark. Since most of the stocks are in the hands of former sellers, demand for the stock goes down thus a need to sell at a lower price than the previous price to sell the stock.

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