Overbought is a common term that you may hear when investing in stocks; you must develop a better understanding of this to successfully trade in the stock market.
What is an Overbought Stock?
Overbought is a term used for those stocks that reach a certain point where indicators suggest that the next price move of the stock will be downwards. When any stock price has risen rapidly and becomes quite expensive for investors, it is an overbought stock. This also states that the stock did exceptionally well to attract the attention of so many traders.
What Happens When a Stock is Overbought?
To buy one stock, there is a massive number of people at one time. The price of any stock rises when the number of buyers exceeds the number of sellers. Ultimately, the stock reaches the price where the traders looking to buy think it's too expensive and high, and they stop buying it. Traders start taking the profits giving rise to sellers rather than buyers. This results in the stock price declining. When the process of profit-taking begins, it's when the stock reaches its resistance point. This is what stock analysts predict and then state that the stock is overbought.
What do Market Makers do?
As soon as the buying interest rises and becomes heavy, a market maker buys an order of shares he doesn't own. He ends up selling the stock short. The market maker makes up for all these sales by buying shares later, and he doesn't mind doing this because, according to his predictions and probability, the stock price will become correct when it becomes overbought. As soon as the price gets corrected, and that's when the buyers think it's got value. This is when the market reaches its makers back, and the market maker repurchases the stock.
Good News Vs. Bad News: How does it Affect an Overbought stock?
Are you wondering how good news and bad news affect an over-bought share? Here's how: If an organization's news circulated in the market, people start believing in what they hear and see potential in the stock. This triggers the buying interest of different buyers and results in an overbought stock going up and becomes more overbought. Although the good news has been predicted, the release of this good news results in profit-taking too. So a stock, if stated as overbought, does not always mean it'll decline in price, but it is an ideal time to profit-take and get the highest returns. So consider taking profits and avail yourself of the chance! Whereas bad news may have an opposite effect, and people may end up worrying and sell off their shares, causing chaos in the stock market.
It's imperative as an investor that you make sure you know all market terms and know when what is happening. This way, you can easily take advantage and end up doing good for yourself.