How do we know if a stock is overbought or oversold? Picture Getty
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One indicator used by chartists to determine an entry or exit point is the “52-week high” signal, which shows how far or close stock prices are to their 52-week highs.
While most chartists believe a 52-week high means there is a strong chance of momentum ahead, it could also indicate the stock has reached its peak.
Academic studies however have shown that there is a “52-week high effect” – ie; stocks with prices close to the 52-week highs tend to have better returns ahead than stocks with prices far from the 52-week highs.
Most technical traders therefore view the 52-week highs as entry signals.
A simple explanation is that if a price has broken out above its 52-week range, there must be some factor that generated enough momentum to further continue the price movement in the same direction.
Similarly, if a stock is far away from its 52-week high, chartists believe the momentum will continue going that way.
Here’s one common strategy which has gained acceptance by the chartists community; it’s called the 52-Week High Rotation Strategy:
This strategy actually goes against the intuitive “buy low and sell high” mantra, but some traders believe it’s good starting point to building an active strategy to beat the market.
| Code | Name | Price | How far from 52-Week High? |
|---|---|---|---|
| ATP | Atlas Pearls | $0.06 | 0.00% |
| FRM | Farm Pride Foods | $0.14 | 0.00% |
| LKO | Lakes Blue Energy | $0.00 | 0.00% |
| KEY | Key Petroleum | $0.00 | 0.00% |
| NPM | New Peak Metals | $0.00 | 0.00% |
| HLA | Healthia | $1.75 | 0.00% |
| CAA | Capral | $8.85 | 0.56% |
| GDG | Generation Develpmnt | $1.54 | 0.65% |
| VTX | Vertex Minerals | $0.17 | 0.75% |
| ABB | Aussie Broadband | $4.16 | 0.83% |
| Code | Name | Price | How far from 52-Week High |
|---|---|---|---|
| XTC | Xantippe Resources | $0.00 | 99.91% |
| DY6 | DY6 Metals | $0.16 | 99.36% |
| DUN | Dundas Minerals | $0.07 | 95.55% |
| CLZ | Deluxe Corp | $0.00 | 95.00% |
| MBX | My Foodie Box | $0.00 | 94.74% |
| AJL | AJ Lucas | $0.01 | 94.21% |
| LML | Lincoln Minerals | $0.01 | 94.00% |
| JRV | Jervois Global | $0.04 | 93.69% |
| PVS | Pivotal Systems | $0.00 | 93.00% |
| EX1 | Exopharm | $0.01 | 92.46% |
Others say the 52-Week High Rotation Strategy is too simplistic, and must be refined with other data to determine whether a stock has been overbought or oversold.
The Relative Strength Index (RSI) is one indicator that’s been used widely to gauge that momentum.
How is the RSI calculated?
where:
U = the percentage of upward-moving days in the last 14 days
D = the percentage of downwar-moving days in the last 14 days
Let’s say you want to calculate the RSI of a stock over the last two weeks (14 days).
If the stock, for example, has risen 10 times in the last 14 days, then:
RSI = 100 – [100 ÷ (1 + (0.71 ÷ 0.29) ) ] = 71.4
Generally speaking, an RSI above 70 is overbought; and an RSI below 30 is oversold. An RSI above 80 is strongly overbought, and an RSI below 20 is strongly oversold.
RSI is in effect a measure of the strength of a stock’s momentum, either in the upward or the downward direction.
Contrary to popular belief, RSI is actually a leading (not lagging) indicator, meaning that it can be used to predict future movements.
In the example above, the stock is overbought and is probably due for a correction.
| Code | Name | 2 Day RSI | 9 Day RSI |
|---|---|---|---|
| SES | SECOS Group | -- | Oversold |
| DGR | DGR Global | Oversold | Oversold |
| JHG | Janus Henderson | -- | Oversold |
| BUB | Bubs Australia | -- | Oversold |
| LEG | Legend Mining | -- | Oversold |
| SIH | Sihayo Gold | Oversold | Oversold |
| PVE | Po Valley Energy | Oversold | Oversold |
| SBR | Sabre Resources | -- | Oversold |
| HYD | Hydrix | -- | Oversold |
| LIN | Lindian Resources | -- | Oversold |
| GGE | Grand Gulf Energy | -- | Oversold |
| STM | Sunstone Metals | Oversold | Oversold |
| Code | Name | 2 Day RSI | 9 Day RSI | 14 Day RSI | 20 Day RSI |
|---|---|---|---|---|---|
| AAR | Astral Resources NL | Overbought | Overbought | Overbought | -- |
| AHC | Austco Healthcare | -- | Overbought | -- | -- |
| NOR | Norwood Systems | Overbought | Overbought | -- | -- |
| PCK | PainChek | -- | Overbought | Overbought | -- |
| FSF | Fonterra | -- | Overbought | -- | -- |
| WEL | Winchester Energy | Overbought | Overbought | -- | -- |
| TMR | Tempus Resources | -- | Overbought | -- | -- |
| DRR | Deterra Royalties | Overbought | Overbought | -- | -- |
| AGC | Aust Gold and Copper | Overbought | Overbought | Overbought | -- |
| PLG | Pearl Gull Iron | -- | Overbought | Overbought | -- |
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