Overbought What is overbought? "Overbought" describes a security whose price has risen sharply and is perceived to be above its fair or intrinsic value. This condition most often signals that selling pressure may increase and a price correction or consolidation could follow. Overbought is not a certainty of reversal — strong trends can remain overbought for extended periods — but it flags heightened risk of a pullback. Explore More Resources

Common causes
* Positive news (earnings beats, product wins, M&A) that drives aggressive buying
* Momentum-driven trading and herd behavior
* Liquidity and low float that amplify price moves
* Short squeezes or other technical pressures that push prices higher rapidly
How analysts identify overbought conditions Fundamental analysis Investors compare valuation metrics, most commonly the price-to-earnings (P/E) ratio, to sector or index peers. A stock with a P/E substantially above its sector average may be considered overvalued and thus potentially overbought from a fundamental perspective. Technical analysis Technical tools measure recent price, volume and momentum to identify overstretched moves. Key indicators: Explore More Resources

  * Relative Strength Index (RSI): Measures the speed and change of price movements over a lookback period (commonly 14 days). RSI ranges from 0 to 100; readings above 70 are typically considered overbought, and readings below 30 oversold. RSI is calculated from the ratio of average gains to average losses, producing a bounded momentum oscillator.
  * Bollinger Bands: Consist of a moving average with bands plotted at a set number of standard deviations above and below. When price repeatedly touches or exceeds the upper band, the asset may be overbought relative to recent volatility.
  * Stochastic oscillator and other momentum tools: Compare closing price to a recent trading range; high readings can indicate overbought momentum.

Combining indicators (for example, RSI > 70 plus price at the upper Bollinger Band) can strengthen the signal, but it also increases the risk of false positives. Practical use and trader responses When a security appears overbought, traders and investors commonly:
Take profits or reduce position size
 Tighten stops or use trailing stops to protect gains
Wait for confirmation (bearish divergence, break of support, lower highs) before initiating short positions
 Look for reversal signals (candlestick patterns, volume spikes on declines) rather than acting solely on an oscillator reading Explore More Resources

Limitations and cautions
* Overbought does not guarantee an imminent decline. Momentum can keep an asset overbought for a long time.
* Different indicators and parameter choices yield different signals; interpretation is somewhat subjective.
* Market context matters: in strong bull markets, overbought readings are more frequent and less predictive of reversals.
Case example (conceptual) A stock’s RSI drops below 30 (oversold) and shortly after the price rebounds — a classic oversold-to-rebound instance. Later, the RSI rises above 70 while price sits at the upper Bollinger Band; the stock then stalls and consolidates. This pattern illustrates how oversold/overbought readings can precede reversals or pauses, but timing and confirmation are essential. Bottom line "Overbought" flags an elevated risk that a recent price advance may be unsustainable. Use both fundamental measures (like P/E) and technical indicators (RSI, Bollinger Bands, momentum oscillators) to assess whether a stock is overstretched. Always combine signals with market context, risk management, and confirmation before making trading decisions. Explore More Resources