Overbought

Definition

Overbought is a term used when a security is considered to be trading at a level higher than its intrinsic or fair value. It typically describes recent or short-term price fluctuations of a security and reflects the expectation that the market will correct the price in the near future. This belief is usually the result of technical analysis of the security's price history, but fundamentals can also be used. Overbought stocks may be a good choice for selling.

Origin

The concept of overbought originated in the field of technical analysis, dating back to the early 20th century. At that time, investors began using charts and technical indicators to predict market trends. As technical analysis became more popular, overbought emerged as an important market signal widely accepted by investors.

Categories and Features

Overbought conditions can be identified using various technical indicators, such as the Relative Strength Index (RSI) and the Stochastic Oscillator. These indicators analyze historical price and volume data to determine if a security is overbought. Features of overbought conditions include rapid price increases, increased trading volume, and overly optimistic market sentiment. While overbought may indicate a price correction, it does not always occur immediately.

Case Studies

A typical case is Tesla, Inc.'s stock performance in early 2020. At that time, Tesla's stock price rose sharply in a short period, and many analysts considered it overbought. Eventually, the stock price adjusted in the following months. Another example is Apple Inc. in 2012, when its stock was deemed overbought after reaching new highs, followed by a price correction.

Common Issues

Common issues investors face when applying the overbought concept include misjudging market sentiment and selling stocks too early. A common misconception is that an overbought condition will immediately lead to a price drop, but in reality, the market may remain overbought for some time.