Extremes are used to determine if an instrument’s Trend or continuous run has reached to an end and is possibly time to exit a trade.
Oversold: Implies that a massive amount of sellers have sold that instrument and therefore it is possible to start seeing the price of the instrument rise. Avoid selling in Oversold markets and is ideal to buy.
Overbought: Implies that a massive amount of buyers have bought that instrument and therefore it is possible to start seeing the price of the instrument drop. Avoid buying in Overbought markets and is ideal to sell.
Neutral : Implies the market is neither Overbought nor Oversold and therefore you can take any action
The picture shows an uptrend moving chart. At various locations arrows point out what the Extremes are expected to be at those locations. Clearly you would want to be a buyer on such a scenario but avoid doing so at the locations where the market is Overbought.
How to measure Extremes
Extremes indicators are oscillators which can signal overbought or oversold conditions when they go above or below certain levels.
1) Stochastic : Measures the location of a current price in relation to its price range over a period of time. Measured in 0 to 100.
2) Relative Strength Index (RSI) : An indicator comparing past closing values with current to test how fast the market has moved. Measured on 0 to 100.
3) Oscillator of Moving Average (OsMA) : Shows the difference between the MACD indicator and its Moving Average.
4) Momentum(MOM) : An indicator showing the difference between today’s closing price and the closed price K days ago to check what the change is.