swing trading

Oversold Stocks - Meaning and How Traders Use It

Stock Market Guides is not a financial advisor. Our content is strictly educational and should not be considered financial advice.

When it comes to the stock market, sometimes you might hear the term "oversold stocks" mentioned. It refers to a stock indicator that is popular among active stock traders.

This article will explain what an oversold stock is and how traders might be able to benefit from finding one.

 

What Exactly Is an Oversold Stock?

An oversold stock is one that has seen a major price reduction recently.

To determine if a stock is oversold, a trader will typically look at the value of its RSI Indicator.

The RSI indicator has a value that ranges between 0 and 100. A stock's recent price history determines its RSI value.

An RSI value of 30 or below indicates the stock is oversold.

You can look up the RSI value of any stock by going to that stock's page on our website.

 

 

That image is a graphical icon that gives an idea visually of what an oversold stock looks like according to its RSI indicator. Notice that when the RSI value goes below 30, the line turns gold, which is an indication that it's oversold.

 

What Does an Oversold Stock Look Like On A Stock Chart?

The image below is an example of a stock chart where the stock is oversold.

 

 

Notice that the price has been declining, and it's punctuated at the end by a particularly sharp drop in price. That price reduction caused the RSI indicator value to go below 30, thereby signaling that the stock is oversold.

The sharper the price reduction, the more of a downward impact it has on the stock's RSI value.

 

How Do Traders Use Oversold Stocks?

Stocks that are oversold have had a lot of recent selling pressure. The idea behind an oversold stock is that the selling pressure might have been excessive and caused the price to go below its fair value. The stock might therefore be due for a rebound in price.

Buying oversold stocks falls into the category of "buy low and sell high". It's buying stocks that are down in price and might offer a discount on their fair value.

Traders take advantage of this by simply buying a stock that is oversold. It's one of the easiest trading strategies to implement.

 

Is an Oversold Stock Bullish or Bearish?

Oversold stocks are considered bullish, meaning that they might be an indication that the stock price is on the verge of going up after having been beaten down in price so much recently.

Since an oversold stock is considered bullish, it means traders might try to capitalize by going long (meaning that they would be buying instead of shorting).

 

How Do You Find Oversold Stocks?

You can find them by using our Oversold Stocks scanner. It's a free tool we offer here at Stock Market Guides. It uses our proprietary scanning technology to find stocks that are in a bull flag chart pattern.

Here's how the scanner results look:

 

That tool ensures that you don't have to waste time flipping through stock charts manually to find oversold stocks.

 

Video About Oversold Stocks

Here's a video that explains oversold stocks and gives examples:

 

Example of an Oversold Stock Trading Strategy

For this example of an oversold stock trading strategy, we're going to use a daily chart, where each price bar represents one day of price activity. That means it would be a swing trading strategy where the trade is designed to last more than one day but not for the long haul.

 

Entry for the Oversold Stock Trading Strategy

The entry for this Oversold Stock trading strategy will be as follows:

The entry criterion for our Oversold Stock trading strategy is very simple. It's a classic RSI trading strategy.

 

Exit for the Oversold Stock Trading Strategy

There are a lot of possibilities here for the exit.

For any given trading strategy, it can be helpful to define three different criteria for the exit: profit target, stop loss, and time limit.

Not everyone uses all three, and that's totally fine. Ultimately, you can set these values however you want. But for the purposes of this strategy example, we will define all three:

 

1. Profit Target

We will set the profit target at 1.5 ATRs away from the entry price.

ATR is an indicator in the stock market that measures a stock's recent price volatility. Most trading platforms have it available as an indicator you can enable.

Our profit target criterion indicates that we will take the ATR value of the stock, multiply it by 1.5, and add it to the price we paid when we bought the stock. That will be our profit target and we can set up a sell limit order at that price.

2. Stop Loss

We will set the stop loss at 2 ATRs below our entry price. This means we take the ATR value of the stock, multiply it by 2, and subtract it from our entry price.

That will be our stop loss and we can set up a stop order at that price.

3. Time Limit

We will set the time limit as one week since this is a swing trade. If the stock has not hit either the profit target or stop loss by the time limit, then we will close the trade manually at the opening bell seven calendar days after entry.

 

How Well Does Buying Oversold Stocks Actually Work?

The idea of an oversold stock trading strategy sounds nice to many people because it offers a clear, easy-to-understand way to find and manage a trade setup.

But does it actually work? Can traders indeed generate profits by trading oversold stocks?

That's exactly what our company can help answer for you, since our scanner technology has allowed us to do our own research on that precise question.

The answer is that trades based on oversold stocks are not always profitable, but many times they are. For certain stocks, they might have a particularly strong track record of success according to our backtest research.

Here is some data that shows how a proprietary oversold stocks trading strategy we created has performed historically according to backtests:

 

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Anyone who signs up for our swing trading scanner service will be able to see stocks that qualify for that trading strategy in real time.

 

Learning More About Oversold Stocks

You can contact us any time if you would like to ask any questions about oversold stocks or anything else related to the stock market.