V.7:11 (385-386): Overbought and oversold indicator by Thom Hartle

Overbought and oversold indicator by Thom Hartle

Traders often refer to markets as being in various states or conditions with a jargon that covers the spectrum of market action. Starting with "It's a bull market. . .the market is overbought. . .the market is consolidating" and moving to "The market is forming a top. . .the market is oversold. . .it's a bear market. . .the market has bottomed. "The point of this article is to explain a simple tool that I use to help me identify overbought and oversold conditions in the T-bond futures market.

Overbought implies that a market has only a minor chance of continuing to move higher. At these points in a rally, buyers are unable to push prices higher. The market may consolidate and, in effect, rest. From a charting standpoint, this resting (consolidating) period will occur at the upper side of a rising trend channel (Figure 1).

The line of resistance, or supply line, of the channel represents a price area that is failing to attract further demand. The market appears to be resting because the news may not be negative enough to change crowd psychology from a bull to a bear trend, yet there is not enough favorable news to attract more buyers.