One of the most famous and powerful tools for this is the Oscillator.
This indicator easily shows you if something is overbought or oversold.
✅ What is a Oscillator?
A oscillator is an indicator that compares a specific closing price of an asset to a range of its prices over time – showing momentum and trend strength. It uses a scale of 0 to 100. A reading below 20 generally represents an oversold market and a reading above 80 an overbought market. However, if a strong trend is present, a correction or rally will not necessarily ensue.
✅ To use the oscillator, it is first important to understand exactly what the readings are showing you.
The oscillator is a bound oscillator, which means it operates on a scale of zero to 100 – this scale represents an asset’s entire trading range during the 14 days, and the final percentage shows where the most recent closing price sits within the range. This makes it easy to identify overbought and oversold signals. Regardless of how quickly the market price changes, or how the market fluctuates, the oscillator will always move in this range.
✅ If there is a reading over 80, the market would be considered overbought, while a reading under 20 would be considered oversold conditions.
✅ If we continue our previous example, a reading of 93.3% would be considered extremely overbought during the 14-day period. Following oscillator theory, this implies that a price reversal would be impending. In fact, some people believe that a reading above 90 is extremely risky and warrants the closing of positions.
✅ The most common use of the oscillator is to identify and divergences – points at which the oscillator and market price show different signals – as these are normally indications that a reversal is imminent. A occurs when the price records a lower low, but the oscillator forms a higher low. This shows that there is less downward momentum and could indicate a reversal. A divergence forms when the market price reaches higher highs, but the oscillator forms a lower high – this indicates declining upward momentum and a reversal.
✅ However, it is always important to remember that overbought and oversold readings are not completely accurate indications of a reversal. The oscillator might show that the market is overbought, but the asset could remain in a strong uptrend if there is sustained buying pressure. This is often seen during market bubbles – periods of increased speculation that cause an asset’s price to reach consistently higher highs.
✅ TradingView lets you use the Oscillator for fast and easy forecasting. You can find it in Indicators & Strategies (f(x)) above your chart.