When the asset's price is higher than its worth, it is overbought.
Traders use a range of tools to determine an asset's "true" value. This engulfs tools from fundamental and technical analysis to daily news items that may shift the asset's perception. In the crypto space, it is difficult to gauge an asset's worth because traders tend to factor in its potential.
Many bubbles were created in such a way. For example, Pirate Chain (ARRR) is a privacy coin designed to make blockchain transactions completely anonymous by default. In contrast, Bitcoin transactions are merely pseudonymous. Based on the supposition that ARRR is bound to grow because of its privacy, many traders have overbought it.
Novel privacy coin Pirate Chain (ARRR) is prone to wild price fluctuations, source: CoinMarketCap.com
However, what they haven't taken into account is that privacy coins are the least likely to be widely adopted by crypto exchanges because they would trigger regulatory authorities into action. Therefore, while the value of privacy may be in demand, it is not likely that privacy coins will reach a significant market cap.
Moreover, when traders see high buy walls for a particular asset, they tend to place a buy order even higher than that, driving the price up even further. This dynamic creates an overbought asset where the price is higher than normal for consecutive days or even weeks. Eventually, a price pullback happens because there is no price support for the asset's worth.
In the cryptocurrency market, which largely consists of small market cap coins, those crypto assets that are overbought are usually so because there is too much liquidity. Because it is easy to enter or exit the market when there is high liquidity, this also means that it is easy for sellers to suddenly close their profits.
The most popular tool to gauge whether an asset is overbought is the Relative Strength Index (RSI). It measures a price momentum, so a trader can see if the price level is coming toward a rally or a selloff. If RSI is over 30, this indicates a bullish momentum - the price should go up.
Bitcoin's price represented by candlestick chart with an RSI, holding at 55, source: TradingView.com
If RSI is above 70, this means the asset is probably overbought. On the other hand, the 40 – 50 range is usually the price support level - the asset's real worth depending on current market conditions. With that said, it bears keeping in mind that technical indicators like RSI are not forecasters.