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Tackle Today: What Does Overbought Mean?

August 15, 2022

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«Too far, too fast.»


With stock indexes up four weeks in a row, cries of “overbought” echo across the land. There’s certainly merit to the warning. The Russell 2000 Index, for instance, has rallied 23% off the lows in virtually a straight line. By definition, overbought means prices have risen a statistically significant amount. There are many ways to measure it, but it suggests we’ve climbed too far, too fast, and could be due for a rest.

But here’s the thing. It takes a strong market to create overbought readings. And prices can remain extended for far longer than you might think. Here are three key takeaways.

Overbought signals DO suggest the risk-reward for new bull trades is getting increasingly difficult.

Overbought signals DO NOT mean prices must fall, particularly when you get an overbought reading in a strong uptrend.

The market can work off overbought conditions through price (by falling) or time (by consolidating). A pullback or pause this week would be a good thing. It will reset many extended stocks and provide cleaner entries. 

Video of the Day: Gino’s Gems: How to add and interpret custom technical indicators arrows on Thinkorswim charts

In today’s Gino’s Gems, Coach Gino Poore teaches how to add and interpret custom technical indicators arrows on Thinkorswim charts (TOS).

Chart of the Day: Russell 2000 ETF ($IWM)

Chart of the Day: Russell 2000 ETF ($IWM)

The Stochastic is deep into overbought territory.

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