What Happens When Stock Markets Are Overbought? Historical Analysis and Insights
When stock markets are overbought, we can expect weaker returns than average over the next few days. But in the long term, returns gravitate toward the average returns. Thus, overbought stock markets only predict short-term results — not long-term.
Our backtest has the following rules:
We buy at the close when the 2-day RSI is above 95.
We sell at the close after N days.
We sell after N days to show how the edge disappears after some time. We use the optimization function in Amibroker to produce the table below.
You can find more info about this trading strategy here:
https://www.quantifiedstrategies.com/what-happens-when-stock-markets-are-overbought/