The term overvalued refers to the state of an asset when studying its valuation or price and observing that it is above what could be considered as its real or fair value.
By definition, something that is priced higher than its real value is called overvalued. Several examples that can be found in the economy in the form of overvalued or undervalued (opposite case), are the actions of a company, real estate, currencies or international currencies or other types of financial assets.
It is common in financial markets that overvalued assets are found, since it is a totally normal phenomenon and that also derives from the existence of a greater demand for that asset.
How do you know if an asset is overvalued?
However, the concept of overvaluation is often confusing and difficult to define exactly as various levels of overvaluation are assumed. That is, a stock can be considered very overvalued or slightly overvalued.
Notable overvaluations often occur based on trends or other emotional and social factors that cause something in particular to overvalue and consequently rise in price in a meteoric way. This has happened in different historical periods such as Tulipomania.
In the economy, overvaluation situations usually end with different events, such as decreases in the price of companies. On the other hand, it is also possible that in the face of a period of continuous overvaluation over time, prices have been inflated and, after excessive inflation, the so-called economic bubbles appear. Something similar happened years ago with the dot-com Bubble.
In the case of currency overvaluations, central banks normally act through devaluations of their currencies if their international price is higher than their real purchasing power.
Usually, overvaluation entails less interest on the part of investors, because there is such a price increase that the price moves away from what is perceived as the real value of the asset in question, so no one would pay so much for something that it's not supposed to be worth it.
In fact, it is in these periods when investment strategies suggest selling and taking advantage of said price to generate a greater profit. It is often thought that when the price is already high, it is most likely that it will fall in the future, that is, there is a high probability that the price will fall.