How to Know If a Stock Is Oversold

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An oversold stock may be a good investment opportunity
An oversold stock may be a good investment opportunity (Image: search.sys-con.com, www.investorsintelligence.com, www.generationaldynamics.com)

Knowing when a stock is oversold is an important skill when stock trading and investing. This article tells readers how to identify possible oversold stocks.

First of all, there are two meanings for an oversold stock. One relates to a stock's price in relation to its uderlying fundamentals. The other relates to a stock's price and its chart (Technical analysis). In this article I will address both.

OVERSOLD STOCK BASED ON FUNDAMENTALS

When a stock price drops enough that the stock is "cheap" in relation to other alternatives or itself, then it could be a good investment opportunity. Fundamentals such as earnings, margins, assets and the company's balance sheet must be analyzed. This is the realm of "value investing". Normally an oversold stock has a low P/E or PEG ratio or a low price to tangible book value.

P/E ratio is an important fundamental
P/E ratio is an important fundamental

OVERSOLD STOCK BASED ON TECHNICALS

To know if a stock is oversold using technical analysis the common tool used is the "stochastic oscillator". This is basically a momentum indicator. It uses two lines, %K and %D to measure the price movements in a stock's (or other asset) price. The two lines are always fluctuating whitin a certain numeric range. The range is between 0 and 100 for both lines. If the reading is above 80 it indicates that the stock could be overbought. It the reading is below 20 it would indicate that the stock is oversold. These numbers are intended to mean that a tren is unsustainable. Keep in mind they could just mean that the prices will be flat for a couple of days before returning to the previous trend.

Chart showing technical indicators. Click to enlarge.
Chart showing technical indicators. Click to enlarge.

I hope this information was useful. For more investment related articles check the resourses section near the bottom of this page.

Tips & Warnings

  • Remember to be diversified!

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