RSI Overbought is a warning sign of an overvalued price - Traders need to know

Correctly reading market signals is a crucial skill for traders, and RSI Overbought is one of the tools that helps indicate when prices are in an overly expensive, dangerous zone. However, many people are still confused about how Overbought differs from Oversold and how to utilize these concepts in trading.

Why Traders Need to Understand Overbought and Oversold

The Overbought Oversold condition is a technical analysis used to measure whether an asset has been overbought or oversold, based on price and volume over a recent period. This understanding helps traders avoid pitfalls:

• Buying at an excessively high price when Overbought
• Selling at an excessively low price when Oversold

In practice, this analysis differs from fundamental analysis because it does not focus on the fair price (Fair Price) but instead looks at momentum and trading timing.

Overbought vs Oversold - Main Differences

When the price enters an Oversold state (excessive selling)

The Oversold condition indicates that selling pressure is excessive, and the price has fallen below its true value. This signal often suggests:

• Selling pressure will weaken
• Buying opportunities may arise
• The price is likely to rebound

The correct decision when Oversold is to avoid further selling and prepare to buy instead.

When the price enters an Overbought state (excessive buying)

The Overbought condition indicates that buying pressure is excessive, and the price is above its true value. This signal suggests:

• Buying momentum will weaken
• Selling opportunities may appear
• The price is likely to correct downward

The decision when Overbought is to avoid additional buying and prepare to sell instead.

Popular Indicators: RSI vs Stochastic

RSI - Measures the strength of momentum

RSI (Relative Strength Index) is an indicator that compares upward and downward momentum.

Formula: RSI = 100 - (100 / (1 + RS))

• RS = Average of upward price changes / Average of downward price changes (over 14 days)

Values range from 0-100, and usage includes:

• RSI > 70 = Overbought (sell)
• RSI < 30 = Oversold (buy)

However, these thresholds can be adjusted based on the asset’s price behavior, such as using 80/20 or 90/10 instead.

Stochastic - Measures the price position within a range

Stochastic Oscillator indicates where the closing price is relative to the highest and lowest prices over a specified period.

%K formula: