Oversold stocks

The stocks listed on the Indian stock market experience daily price movement due to variations in forces of demand and supply. These price movements often sustain for extended periods, pushing stocks into overbought and oversold zones.

What Are Oversold Stocks?

Oversold stocks are those listed shares that have seen high-selling pressure from investors on a trading day. Due to such high-selling activity, these shares experience immense price declines and trade below their true value, becoming oversold stocks.

One important thing to note here is that oversold stocks are a subjective term. This means that one trader or investor can consider a stock oversold due to extensive selling, whereas the other might treat such selling as a normal price movement.

Oversold stocks are identified using technical indicators such as the Relative Strength Index (RSI) or fundamental ratio measures like the price-to-earning (P/E) ratio. You can also use stock screeners to ease your research for oversold stocks.

• Stocks that trade below their true or intrinsic value due to extensive selling are called oversold stocks.
• These shares can identified using technical indicators, fundamental ratios and stock screeners.

What Does an Oversold Stock Indicate?

An oversold stock indicates the following:

1. Increased Selling - When a stock enters the oversold zone, it reflects that investors have sold their holding in that particular stock in large volumes. As a result of this high selling volume, the stock prices plunge significantly.
2. Possible Buying Opportunity - Oversold stocks represent a potential buying opportunity because a decrease in the prices of quality stocks allows investors to buy them at a lower cost and increase their earning potential.
3. Negative Investor Sentiment - When there is a negative market sentiment among investors for a particular stock, the prices of the stock decline sharply due to high selling. Eventually, the selling pressure pushes the stocks or a company’s shares into the oversold zone.

What Causes Oversold Stocks in the Share Market?

Stocks can become oversold due to the following reasons:

1. Weak Financial Performance - Companies with weak and inconsistent financial performance are not favoured by investors much. Thus, a prolonged negative performance leads to selling and huge price declines.
2. Economic Turmoils - During wartimes, large epidemics, or emergencies, economies face huge difficulties. Due to such conditions, investors liquidate their portfolios to avoid losses, which results in an increased number of oversold stocks in the market.
3. Unfavourable Company News - News or events such as unstable management or being party to a fraud or scam make investors lose confidence in a company. As a result, investors sell shares of such companies in large quantities and plunging prices to a great extent.

Risks of Transacting In Oversold Stocks

Many traders prefer to trade in oversold or overbought stocks to benefit from possible trend reversals. But as we know, stock market trading is an act of probability and calculative chances. Therefore, trading or investing in these stocks can be risky.

Now, the primary risk that oversold stocks have is that they mislead stock market participants, especially traders, about a trend reversal. This is because when a stock experiences extensive price decline, buyers are expected to push the price up again from the low price levels. However, in many cases, oversold stocks are pushed further lower from their current levels due to negative market sentiments, which leads to losses for buyers who were expecting an upward trend for the stock.

Another crucial risk is the duration of the bearish trend in the oversold stocks. When a stock enters the oversold zones, it means that the stock is trading with a bearish trend. For short-term traders who prefer frequent entry and exit, it becomes very difficult to decide on the duration for which oversold stocks can sustain a negative momentum. Thus, making profits by trading in oversold stocks becomes much riskier.

• Investing or trading in oversold stocks does carry some implied risks.
• Oversold stocks can provide misleading signals about possible trend reversals and the duration for which they can trade in a bearish trend.

How To Identify Oversold Stocks?

Investors can use various technical and fundamental tools to identify and invest in oversold stocks in the Indian market. Along with these tools, you can also use stock screeners to access the oversold stocks list. Read below to learn more about the tools available that can help you identify oversold stocks:

Technical Indicator for Oversold Stocks

Relative Strength Index (RSI): The Relative Strength Index (RSI) is a momentum oscillator traders use to analyse the strength and direction of stock prices. The primary goal of RSI is to help traders identify oversold and overbought stocks through a line graph that oscillates on a scale of 0 to 100. Typically, when the RSI value of a stock is above 70, it indicates that it is an overbought stock, whereas, on the contrary, a value below 30 tells that it is an overlord stock. The Relative Strength Index (RSI) is one of the most preferred technical indicators that helps analyse the momentum of a stock and identify buying and selling opportunities.

Fundamental Indicator for Oversold Stocks

Price-to-Earnings (P/E) Ratio - The Price-to-earnings (P/E) ratio is an important measure used in the fundamental analysis of securities. The P/E ratio is a crucial metric for checking whether a stock is overvalued or undervalued. It can also be used to identify oversold stocks because when a stock has a low price-to-earnings (P/E) ratio, it may indicate decreasing stock prices due to extensive selling by investors. However, a low (P/E) does not always mean a stock is oversold. Low P/E can also occur due to the increase in the value of earnings per share (EPS).

Stocks Screeners for Oversold Stocks

Stock Screeners: Investors may sometimes find the relative strength index (RSI) or the price-to-earnings (P/E) difficult to understand. Hence, investors or traders who do not possess the knowledge to use these indicators can identify the oversold stocks by using stock screeners. These screeners provide you with a list of stocks that have entered into the oversold zone.

• RSI - It is a technical indicator used to gauge the direction and strength in the price movement of shares. Traders use the RSI to identify oversold and overbought stocks.
• P/E Ratio - The price-to-earnings ratio is a fundamental ratio that helps investors decide whether a particular stock is overvalued or undervalued. It represents the relationship between the price and earnings per share (EPS) of a listed company.
• Stocks Screeners - Stocks market screeners are tools used to filter out a list of stocks based on certain criteria. These screeners can also be used to filter oversold stocks in the markets.

Key Takeaways On Oversold Stocks

• Oversold stocks are those listed stocks that have experienced large price corrections or declines due to high selling activity from investors.
• Oversold stocks mean that the value of a company’s share has dived down extensively, sometimes even less than its true value.
• A high selling pressure that pushes a company's stock into the oversold zone can be caused by various factors. These factors include the company’s bad financial conditions, negative news or events or an economic downturn.
• Investors also look for oversold stocks to analyse buying opportunities to acquire quality stocks at lower prices.
• Indicators and tools such as the Relative Strength Index (RSI), Price-to-Earnings (P/E) ratio, and stock market screeners can help you identify oversold or overbought stocks easily.
• Oversold stocks can also be risky for investing and trading because they can provide false signals.