Momentum is a measurement of how far a stock has moved in a given period of time. If selling forces the stock to trade at an extreme below what would be its typical trading range, it’s considered to be oversold. If buyers push a stock to an extreme above what would be its usual range, it’s considered to be overbought.
Traders try to profit from oversold and overbought conditions. They will be expecting a reversion to the average. Two of the indicators that traders use to measure momentum are Bollinger Bands and the RSI indicator.
On the following chart of NIO Inc. (NYSE:NIO) the two blue lines are Bollinger Bands. They are two standard deviations above and below the 20-day moving average.
Many times when stocks exceed these important thresholds, they tend to reverse.
The bottom part of the following chart is the RSI Indicator. If the blue line is above the red line, it indicates overbought conditions. If it is below the lower blue horizontal line it shows oversold conditions.
Over the past 10 months, when these two indications simultaneously showed over-bought conditions, it was a good time to sell. When they showed the stock to be oversold, it was a good time to buy.
Investors who are interested in trading models should join the Benzinga Trading School.