Often, while trading in forex, we come across news such as the EUR/USD currency pair is oversold and is going to bounce back soon. For a trader fact like these can be the difference between profit and loss. But what does a currency pair being oversold mean and what are its consequences on currency trading?
A currency pair being oversold or over bought depends on the ratings of an oscillating indicator like RSI or Stochastic indicator. The oscillators aim to map the current price trends and compare them with similar trends in history. The oscillating indicators measure on a scale of 0 to 100. For RSI, the value for overbought is 70 and for oversold is 30. Similarly, for Stochastic indicators, when the measure reaches 80, it indicates an overbought currency pair, while 20 means oversold.
Do Oscillating Indicators Suit Your Currency Trading Scheme?
Oscillating indicators work by analyzing past market trends. They try to relate current market trends with market movements of the past. Using this data, they predict the oversold or overbought position of every currency pair. Such indicators work on the belief that either extreme implies a reversal in market trends. But this is not always the case.
A market moving forward can remain in this trend despite being overbought for a long time and the same is true for falling markets (which can stay in the oversold position for long periods of time). This way, any trade based on these predictions can draw in huge losses. So, why are they still used?
Prediction of market fluctuations is never easy. Oscillators have one advantage. If in a falling market, the indicator shows overbought conditions, then reversal will occur. Similarly, an oversold rating in an upward moving market will also lead to reversal. This prediction capability of oscillators has kept them in the trading arena till now.