Forex Trading - Why Trying To Determine Overbought And Oversold Positions Is A Dangerous Game

There are many different methods used by traders to trade the forex markets. One of which is to constantly be on the look out for overbought and oversold positions, but is this really the best way to trade?

If you have any experience at all of trading, whether it's forex trading or stock market trading, you will know that it's virtually impossible to consistently enter a position at the exact top or bottom of an instrument's trading range.

Even with the use of multiple technical indicators it is extremely difficult to do. Sure you may get lucky every so often but the reality is that most of the time you will enter a position too early and sometimes the price may just race through what you perceived to be the top or bottom.

It's important to realize that a currency pair can remain overbought or oversold for a very long time, and just because tried and tested indicators like stochastics and RSI, for example, indicate that the price is overbought or oversold does not mean that the price cannot go a lot higher into an even greater overbought or oversold position.

This is true in both short and long time frames, and can often result in a trader's stop loss being quickly hit as the price continues to become even more overbought or oversold.

For this reason my own personal preference is to follow the overall trend and not try and second guess the market, because this is what you're ultimately doing when you're trying to call tops and bottoms all the time. You're effectively going against the trend and over time this is not the most profitable way to trade in my opinion.

A more effective way of trading is to wait for confirmation of a reversal before entering a position. Yes you may not yield as many points trading this way, but it's much easier to go with a trend than fight against it.

For example as well as using traditional overbought and oversold indicators you could use crossover indicators such as MACD, TRIX and EMAs to indicate that a true reversal is taking place. You can also wait until short term support and resistance levels are breached for additional confirmation.

The main point I want to get across in this article is that if you're just using certain indicators to call the top or bottom of a market, or worse still just using your own intuition, you are playing a very dangerous game, and you are unlikely to make consistent profits in the long run.

If you do choose to trade this way you're much better off sacrificing a few points by waiting patiently for additional confirmation that a true reversal is taking place.