When a cryptocurrency has been purchased by more and more investors over time, with its price increasing for an extended period of time.
Overbought is a term used to describe a phenomenon where a cryptocurrency price increases over time due to continued investments, but without a supporting investment rationale. Usually, a selling period follows an overbought condition. In other words, a crypto asset enters the overbought region when it is believed to be trading above its fair value.
The occurrence can be long or short-lived, and the price may tank if the phenomenon reverses. In the digital currency ecosystem, technical analysis is one of the tools used to determine if an asset is overbought and when the trend is likely to make a U-turn.
Fundamental analysis, which involves evaluating publicly available information tied to industry and macro-economic factors, can also be used to unearth an overbought condition. In addition, fundamental analysis helps forecast when a cryptocurrency will abandon its unsupported upward price increase.
Measuring overbought levels through technical tools involves factors such as traded volume, recent price and trading momentum. Examples of technical formulas used to indicate an overbought level include the relative strength index (RSI), stochastic and Williams %R. RSI factors in the trading speed and the price fluctuation; it records the levels with values between 0 and 100, with anything above 70 indicating an overbought signal.
The stochastic, on the other hand, shows an overbought level by comparing the current asset price with its highest and lowest price over a given period. On a scale of 0 to 100, a rating of 80 shows it is overvalued.
Williams %R evaluates how the current price compares with the highest price over a given period called lookback. A value of 20-0 indicates an overbought level. In 2020, for instance, the RSI showed that Bitcoin reached overbought levels in February when it clocked the $10,000 mark.