What Is a Sell Signal?
A sell signal is a condition or measurable level at which an investor is alerted to sell a specified investment and can have an impact on performance.
A sell signal can be generated through a variety of methods, such as a pre-determined percentage decline in the asset's value, a technical indicator, a fundamental change in the asset, or a trailing stop-loss. The sell signal may automatically close the trade, like in the case of a stop-loss order, or the investor/trader may need to manually close the position after receiving the sell signal from their method/strategy.
- A sell signal is anything that alerts a trader to sell an asset.
- Sell signals are typically based on fundamental or technical analysis.
- Sell signals can be automated, like with a stop-loss order, or the sell signal may only alert the trader to sell and then they implement the sell order manually.
Understanding Sell Signals
Sell signals can be generated from a variety of signaling methods. They are used by all types of investors and traders, from day traders to long-term investors. Fundamental analysts generate sell signals when a security’s fundamental value reaches a certain level. The sell signal could be based on the fundamentals reaching historically high levels, or because they are starting to decline.
Technical analysts will use charting techniques to generate sell signals based on technical patterns and indicators. For example, if an asset falls below a support level, the technical trader may view that as a sell signal. If an asset falls below a certain level on a technical indicator, or becomes overbought and starts to decline, or falls below a moving average, these could all be used as potential sell signals. Other investors may simply follow the market for sell signals, selling when the major indexes experience a high-volume selloff.
Regardless of the type of methodology used, many investors will have a pre-determined level identified as a sell signal. Sell signals may be developed at the onset of an investment, and that level may be adjusted over time as conditions change. The sell signal may also be established during the life of an investment as developments occur or risk tolerance levels change.
Stop-loss orders are one of the best ways to implement risk mitigation and manage potential losses. Investors can easily adjust stop-loss order price levels if a sell signal level changes over time.
Fundamental Analysis Sell Signal
Fundamental analysts build financial models for the valuation of an asset-based on certain variables. They may use discounted cash flows, which uses a breakdown of company earnings and free cash flow to generate a market valuation through discounting. This methodology is typically built to generate a range of values for a security using different assumptions. Thus, various scenarios and assumptions can generate price level ranges for which an analyst believes it is best to buy or sell a security.
Analysts may also use other parameters and metrics that may lead to a sell signal. Debt signaling may cause a sell signal when a company’s total debt to assets rises above a certain level, for example.
Other investors may sell when earnings growth starts to decline, or when the price/earnings (P/E) reaches a level that doesn't justify future earnings prospects.
Technical Analysis Sell Signal
Technical analysts will focus on charting patterns and technical tools to provide sell signal alerts. Some may watch for a decline below a supporting trendline to generate a sell signal. Others may sell into strength, choosing to exit when the price is rallying aggressively to the upside.
Chart patterns, such as triangles and head and shoulders patterns, have their own sell signals. Each pattern has a profit target for taking profit on profitable trades, and a stop-loss level for cutting losses if the trade doesn't work out.
Technical indicators are also used to generate sell signals. A trader may watch for indicator crossovers, such as a MACD crossover, or a shorter-term moving average crossing below a longer-term moving average. A trader may also use levels on an indicator to signal an exit, such as when the relative strength index (RSI) falls below 30, or rises above 70 but then falls below it.
Sell Signal Example
Assume a trader heavily relies on the 100-day moving average (MA) as part of their trading strategy. They like to buy when an uptrending stock touches the 100-day MA but doesn't fall more than a few percent below it. When the price starts rising off the MA they buy. If the price drops through the MA and keeps dropping, they do nothing. If they are in a long trade, they sell if the price falls more than 4% below the MA.
Here's an example of how these rules could have been applied in Apple (AAPL) stock.
As the price starts its uptrend, it tests the 100-day moving average but quickly starts to rise off of it, which generates a buy signal. On the next two tests, the price marginally drops below the MA, but not by the 4% (or greater) required to generate a sell signal. The trader could maintain their position or add to it at these junctures.
On the next test, the price falls below the MA by more than 4%, which causes a sell signal and the trader exits their position.
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