The first interest of oscillators, linked to their tension
indicator status, is to mark sensitive levels, forecasting possible reversals.
It is for this reason that the “overbought” and “oversold”
concepts have been set up. These levels correspond to market excesses. For
example, in the case of an overbought situation, the stock rose steadily without
consolidating or correcting significantly, thus letting expect a forthcoming
reversal. This is expressed by the oscillator at a high level, in a zone, which
has been defined as oversold area and which shows the existing tension on the
market. This is also the case, symmetrically, on the downside while, between
both extremities, the market is considered as neutral.
Still, reading these overbought and oversold zones can be
more complex. Indeed, oscillators can take two different forms, with or
without boundaries. Indicators with boundaries evolve between two fixed
limits (often 0 and 100). It is then easy to determine these zones (for example
above 75 for overbought and below 25 for oversold). In comparison, indicators
without boundaries, by definition, have no theoretical limits on the upside and
on the downside, which makes it more difficult to set up such zones. However,
though it is careless to buy in an already overbought market, the sole analysis
of the indicator level does not necessarily give all information (see
graph).