Situation of overbought market condition occurs when public accumulates extremely long inventory (even if smart money players are not too short). The same situation occurs when they hold extremely short inventory – we say that market is «oversold» in this case
Liquidation is the result of Overbought Market Conditions
.
Hi traders!
We hear it very often that market is «overbought» or «oversold». But is it really possible to understand this looking at the single price chart without knowing real open interest (we don’t have this information for Forex currency pairs)? Some traders try to use RSI or other oscillators (divergences as usual) to spot «overbought» or «oversold» market.
First, let’s define what overbought (oversold) market is.
We all know that for every buyer there has to be a seller to have transaction executed, otherwise there’s no trade. So, how in the world can we have something «overbought» or «oversold» - do we really assume that there can be more buyers than sellers?
Let’s distinguish market participants of 2 parts: Smart money (institutional players) and public. Smart money often have information about large orders, they have access not only to interbank liquidity, they also execute orders of big clients, so they know what big guys are going to do – they work on the behalf of those big guys. On the other hand, we have «public» - uninformed market participants that usually just react and don’t have access to real liquidity.
Does really «public» exist on Forex? After all, it’s interbank market with minimum position size of 1 million. By «public» I understand not really retail traders that operate with 100 USD accounts, not at all. By public I mean orders brought to the marketplace by large ECN networks like EBS, Currenex e t.c. Such marketplaces collect smaller positions from retail traders all over the world and hedge them in the interbank market
.When small traders are very optimistic about possible growth, they bring a lot of fragile positions to the marketplace. Not surprisingly, market can liquidate (go down) very quickly if something happens.
And market has liquidated after news release on Aud/cad– rapid movement to the downside was result of massive liquidation: