Recent volatility in the stock market that caused short-term price extremes has made it important for investors to understand the difference between overbought and oversold.
Just to be clear, oversold is the exact opposite of overbought.
Overbought is a situation in which the demand for a certain asset unjustifiably pushes the price of an underlying asset to levels that do not support certain fundamentals. It happens when an asset that has experienced sharp upward movements over a very short period of time is often deemed to be overbought. Actually determining the degree in which an asset is overbought is very subjective and can differ between investors.
Oversold, on the other hand, is when the price of an underlying asset has fallen sharply, and to a level below where its true value resides. This usually occurs as a result of market overreaction or panic selling.
In this case, assets that have experienced sharp declines over a brief period of time are often deemed to be oversold.
Gary Kaminsky, Morgan Stanley's vice chairman of wealth management, explains.