The Hindu Business Line : Strategy

The concept of overbought or oversold is subjective in nature and may vary across time and with the overall trend in the market. If the price of a stock or an index moves up too fast in too short a span, then the instrument concerned would be pushed to an overbought zone.

When this happens, the price would take a breather in the form of a downward trend or sideways correction. An oversold condition is just the opposite of overbought situation.

There are quite a few technical tools to identify an overbought or oversold condition.

The Relative Strength Index (RSI) and Commodity Channel Index (CCI) are reliable tools in this regard. A much better tool would be a measure of how far the price has moved away from its moving average.

Almost all popular software packages have an inbuilt tool to measure this distance from moving average.

Prices normally turn direction once they move a particular level away from their moving average.

There is no hard and fast rule to define a particular set of numbers to describe overbought or oversold condition using this tool. Just an eyeball assessment of the past price action would be sufficient to decide where the stock would get overbought or oversold.

Always try to measure overbought or oversold condition in a time frame that is longer than the time frame in which you trade. For instance, if you trade based on daily price charts, try to identify overbought or oversold condition in the weekly charts. Always take investment or trading position in sync with the trend in the longer time frame.

If the stock is an upward trend and has reached an oversold region in the weekly chart, then, look to go long if the stock gets closer to the oversold position in the daily charts. Another way to use overbought or oversold study is to defer an investment decision if the stock has reached an overbought or oversold region. In effect, it is an essential tool to time the entry or exit.

I am a beginner in stock market and trying to understand the basics of technical analysis. On March 29, the share price of VSNL shot up by nearly 11 per cent and there were reports subsequently that suggested that the share price rose on news that the real estate holdings of the company that might prove beneficial to shareholders. My senior colleagues were of their view that the stock rose only because of the technical breakout, which was long overdue and not because of the news. Please explain who is correct. R.Ganesh, Sameer Grover

Both the views are correct in this instance case. People who believe in technical analysis would prescribe that the spurt in share price was on account of a technical breakout.

Those who do not subscribe to the study of technical analysis would always try to attach some fundamental development to justify a move in the share price.

The bottomline is that both of them are correct in their own ways.

You must realise that technical analysts operate on the premise that the impact of all events pertaining to a company would get reflected in the share price of the company concerned.

Hence, by studying price patterns and using other technical tools, it would be possible to determine where the share price is headed. A technical analyst generally is not bothered about the cause or reasons for expecting the share price to move in a particular direction.

The fundamental analyst is interested in analysing factors or developments that have an influence on a company's fundamentals.

They try to find the cumulative impact of such developments on the earnings stream and determine how far the share price could move based on them.

B. Krishnakumar

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