Overbought – what is it?

Growth eventually comes to a halt, and a reversal occurs. The main task of a trader is to accurately determine the moment when it will happen because not every stoppage indicates an imminent reversal. Indicators can help in this regard, particularly those indicating that an asset is overbought - meaning that most traders who intended to buy it have already done so and are now looking for a moment to sell.

Among the indicators that can help determine if an asset is overbought are Bollinger Bands, Stochastic, Chande Momentum, and others. The Relative Strength Index (RSI) is commonly used because it is simple and convenient: it has two lines - an upper line and a lower line. If the RSI chart crosses the upper line from below to above, it indicates that the asset is entering an overbought condition. This does not necessarily mean that the price will soon fall, but sooner or later it should happen. If instead the price continues to rise and reaches a new local maximum while the RSI level fails to reach the same local maximum, it indicates a bearish divergence - which in most cases signals a significant decline in the price in the near future. Increasing selling volumes can also be an indication of this.

The RSI, like other indicators, is not the ultimate truth. It can be adjusted and interpreted differently, so it is advisable to use a combination of different tools to determine exit points from an asset. Often, RSI is used not as a source of signals but as a filter for them: buy signals are ignored when RSI is in an overbought state, and sell signals are ignored when it is oversold.

In any case, when an instrument is overbought, it is important to be cautious in order to avoid losing profits, especially when dealing with cryptocurrencies, which can plummet by tens of percentage points in a matter of minutes.