What Is an Oversold Bounce?

An oversold bounce is a rally in the prices of securities that occurs due to the selloff preceding it being perceived as too severe. It may be short-lived in nature, as underlying fundamentals may still point to lower prices; however, the speed of the sell-off may have been too severe initially, prompting the bounce.

The opposite price action from an oversold bounce would be a selloff resulting from prices being 澳洲幸运5官方开奖结果体彩网:overbought.

Understanding an Oversold Bounce

Before an oversold bounce, due to behavioral tendencies such as 澳洲幸运5官方开奖结果体彩网:herd behavior, aversion to loss, and the temptation to panic, prices can decline more than they should based on technical and/or 澳洲幸运5官方开奖结果体彩网:fundamental analysis. Such price action c🐷an occur in any num🐻ber of markets including stocks, bonds, and commodities.

An oversold bounce implies that prices are correcting themselves upward because they went too low just prior to the bounce. Being oversold means that the price of an asset or market has fallen to a level below its 澳洲幸运5官方开奖结果体彩网:fair value. Negative 澳洲幸运5官方开奖结果体彩网:macroeconomic data such as employment figures or 澳洲幸运5官方开奖结果体彩网:gross domestic product (GDP) missing their estimates can♒ cause broad selloffs while company-specific data such as poor corporate earnings or downward guidance can do the same to an ඣindividual stock. 

How to Spot Oversold Conditions

The determination as to whether prices have fallen to a level that is oversold can be based on fundamental analysis or technical analysis. On the fundamental side, if prices have been sold down lower than the 澳洲幸运5官方开奖结果体彩网:book value or 澳洲幸运5官方开奖结果体彩网:intrinsic value, there may be a strong case that it was oversold, or if the low price implies a 澳洲幸运5官方开奖结果体彩网:price-to-earnings (P/E) ratio that is suddenly much lower than its peers. Often, an oversold condition will be motivated by fear.

With technical analysis, being oversold can be judged 澳洲幸运5官方开奖结果体彩网:by looking at technical indicators. Prices that fall below a moving average, for example, might indicate the price is too low. Oftentimes, indicators such as 澳洲幸运5官方开奖结果体彩网:oscillators are employed to determine a potential lower bound that, if reached, would point to being oversold. The 澳洲幸运5官方开奖结果体彩网:relative strength index (RSI), stochastic oscillator, 澳洲幸运5官方开奖结果体彩网:moving average conve⛦rgence divergence measure (MACD), and 澳洲幸运5官方开奖结果体彩网:money flow index are all used by market technicians to spot oversold conditions.

When enough market participants deduce that the price of an asset is oversold, they are like💖ly to enter that market as buyers to bid up that price to at least the equilibrium level it should be at based on technical measures or valuation models. Because many people may come to this conclusion at the same time and compete with each other to buy undervalued shares, prices tend to bounce up quite quickly.

If there are many 澳洲幸运5官方开奖结果体彩网:short sellers in an oversold market, the ensuing bounce may be even more pronounced as those shorts are forced to cover in a 澳洲幸运5官方开奖结果体彩网:short squeeze. Being oversold is a subjectiveಌ measure even though it has objective considerations. As such, not every "oversold" asset will experience such a bounce.

Example of an Oversold Bounce

Company ABC's stock trades at a price of $100. In their latest 澳洲幸运5官方开奖结果体彩网:quarterly earnings report, the company announced 澳洲幸运5官方开奖结果体彩网:earnings per share (EPS) at $1.45. Analysts had estimated that the EPS would be $1.51. This combined with the recent news that Company ABC will have to pay a court settlement of $2 million causes investors to be bearish on the stock. As a result, investorꦅs start selling. As other investors notice the price of the stock falling as well as the news, they start to sell too. Over one month, the price of Company ABC's stock goes from $100 to $85.

After this month, investors realize that the stock has fallen rapidly, particularly when compared to its book value, believing it is underpriced, or oversold. This combined with the fact that the company has cash reserves of $20 million, making the $2 million court settlement not a large issue, results in investors buying the stock again, as the long-term prospect of the company remains strong. Investors start quickly buying the stock again, the price increases, other investors jump on the bandwagon, and the stock experiences an oversold bounce.