Overbought

Overbought and Oversold are terms commonly thrown around by market participants, but yet each person has a different definition of overbought and oversold.  The most common definition of OB or OS comes from the Stochastic indicator.  With anything above 80 as overbought and below 20 as oversold.  This indicator can give false signals though and most of the time each stock has it's own number above 80 which represents overbought.  Oscillators are good to determine if an individual stock is overbought or oversold, but to determine if the overall market is oversold one must look at different indicators. 

The first indicator to look at is the volume of the market.  The below chart is the NY Up Volume to Total Volume ratio, with a 8 day ema on it.  Notice when the 8 day ema moves above the HL the market tends to decline.  The line represents the amount of up volume to the overall volume has reached a peak and there is to much buying going on. 

Another indicator to look at it is NYMO, NYMO closed on Friday with a reading above 79 which is very high for this indicator.  NYMO is at an extreme level and the last time it was at this level the market sold off.  When NYMO gets to these extreme the market tends to move lower as well. Of course this isn't 100% accurate since there was another month long rally on a NYMO that was near these levels.

Of course an OB or OS condition isn't 100% accurate as buy or sell signals because of course there is the old saying "A market can stay overbought and oversold longer then you can stay solvent".  Noticing an OB or OS market allows a trader to plan accordingly.