Shares of Bitfarms Ltd. (NASDAQ:BITF) are trading lower on Wednesday. The stock started to head down last week after announcing convertible note offering.
Bitfarms reversed after becoming extremely overbought. This is why it is our Stock of the Day.
Many trading strategies and models are built around the concept of reversion to the mean. If a stock gets overextended in one direction or the other, traders will anticipate a reversal.
If a stock has been aggressively bought and rises above its typical range, it is considered overbought. This will draw sellers into the market, and they could put downward pressure on the shares.
Sometimes, when a stock is extremely overbought, traders and investors are unsure where to sell. They don't want to sell too soon, because then they are leaving a potential profit on the table.
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Some use momentum indicators to gain insight into when to exit.
The red line on the Bitfarms chart below is two standard deviations above the stock’s 20-day moving average. Statistics and probability theory suggest that 95% of trading should be within two standard deviations of the mean.
If a stock exceeds this threshold to the upside, it is considered to be overbought.
Some traders sell when the stock gets back below the red line. This could mean the overbought conditions are fading and a reversal is imminent. As you can see on the chart, this would have been an effective strategy here.
The lower part of the chart is called the Relative Strength Index (RSI). When the blue line is above the horizontal red line, it indicates oversold conditions. A potential exit strategy would be to sell when the blue line reverses and starts to head lower.
That would have been a good strategy here as well.
Good traders let the market tell them what to do. When an oversold stock starts to become not oversold, it could mean a reversal is coming.
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