What is a 'Trade Signal'

A trade signal is a trigger for action, either to buy or sell a security or other asset, generated by analysis. That analysis can be human generated using technical indicators, or it can be generated using mathematical algorithms based on market action, possibly in combination with other market factors such as economic indicators.

BREAKING DOWN 'Trade Signal'

Trade signals can use a variety of inputs from several disciplines. Typically, technical analysis is a major component, but fundamental analysis, quantitative analysis, and economics can also be inputs. They can include sentiment measures and even signals from other trade signal systems. The goal is to give investors and traders a mechanical method, devoid of emotion, to buy or sell a security or other asset.

Aside from simple buy and sell triggers, trade signals can be used to modify a portfolio by determining when it might be a good time to buy more of one particular sector, such as technology, and lighten up on another, such as consumer staples. Bond traders could have signals for adjusting the duration of their portfolios by selling one maturity and buying a different maturity.  And finally, it can also help with asset class allocation such as shifting money among stocks, bonds, and gold.

There is no limit to how complex a trade signal can be. However, traders tend to keep things simple by using only a handful of inputs. For practical purposes, it is far easier to manage a simple signal generator and periodically test it to see what components need adjusting or replacing. Too many inputs would introduce complexity requiring more time than a trader has to offer. And since markets change over time, often with great speed, complex strategies could be rendered obsolete before testing is even finished.

Creating a Trade Signal

There are endless possibilities when coming up with a trade signal, but traders tend to just want to automate their thinking. An example might be, "for a stock with lower than a certain price-earnings ratio, buy when a certain technical formation breaks out to the upside, and prices are above a certain moving average while interest rates are falling."

Here are several of the more common inputs. Traders can combine them as they wish to meet whatever criterion they use to select trades.

  • Technical pattern breakout or break down. These can include triangles, rectangles, head-and-shoulders and trendlines.
  • Moving average cross. Most investors watch 50- and 200-day moving averages but there are many others in common use. The input could be when trading activity crosses above or below the average. Or it could be when two averages cross each other.
  • Volume surge. Unusually high volume is often a precursor to a new move in the market. In the futures markets, open interest can also be used.
  • Interest rates. Changes in rates can often suggest changes in stock and commodity markets.
  • Volatility. There are many ways to measure volatility, and as with other indicators, extreme highs or lows in volatility can trigger market changes.
  • Cycles. Markets of all types tend to ebb and flow over time, even if they are in a steady trend or in a non-trending condition. One of the more widely known cycles is the seasonal cycle for stocks —sell in May and go away —which could help determine if a strategy is operating in the strong or weak half of the year.
  • Sentiment extremes. Used as a contrary indicator, excessive bullishness according to surveys or actual trading activity can suggest market tops. Conversely, excessive bearishness can lead to market bottoms.
  • Valuation. An excessively high valuation compared to market, sector, or stock specific measures can lead to sell signals.
RELATED TERMS
  1. Debt Signaling

    Debt signaling is a theory that associates the future performance ...
  2. Technical Analysis

    Technical analysis is a trading discipline employed to evaluate ...
  3. Automatic Execution

    Automatic execution helps traders implement strategies for entering ...
  4. Technically Weak Market

    Technically weak market reflects fragile signals or negative ...
  5. Technical Indicator

    Technical indicators are mathematical calculations based on the ...
  6. In And Out

    In and out is a trading strategy whereby shares of a single security ...
Related Articles
  1. Trading

    Trend Trading: The 4 Most Common Indicators

    Learn about the top indicators and tools trend traders use to establish when trends exist and find entry and exit points.
  2. Trading

    Tackling Technicals For Beginners

    Choosing the right indicators can be a daunting task for novice traders. It’s a much easier process when they focus their effects into five categories.
  3. Investing

    The Contrarian: About BAML's Sentiment Indicator

    Bank of America/Merrill Lynch's Sell Side Indicator measures investor sentiment, badly.
  4. Trading

    Trade Forex With A Directional Strategy

    Opening long or short positions to cash in on a trend is one of the simplest ways to trade forex.
  5. Trading

    Introduction to Stock Trader Types

    What type of stock trader are you?
  6. Trading

    Measuring Stock Market Sentiment With Extreme Indicators

    Pay attention to how the exhaustion principle helps technical indicators signal trend reversals when abrupt value changes coincide with high trading volume.
  7. Investing

    Use This ETF to Trade Apple (AAPL)

    Volume is a good indicator of money flow, and when paired with volatility, can lead to profitable trades. This ETF follows such a pattern.
RELATED FAQS
  1. What is the difference between fundamental and technical analysis?

    Fundamental analysis and technical analysis, the major schools of thought when it comes to approaching the markets, are at ... Read Answer >>
  2. Is it better to use fundamental analysis, technical analysis, or quantitative analysis ...

    Understand the difference between fundamental, technical and quantitative analysis, and how each helps to evaluate long-term ... Read Answer >>
  3. How is sensitivity analysis used?

    Sensitivity analysis is used to identify how much variations in the input values for a given variable will impact the results ... Read Answer >>
  4. How do I use Stochastic Oscillator to create a forex trading strategy?

    Learn about the stochastic oscillator and how to it is used to create an effective forex trade strategy, including how to ... Read Answer >>
  5. How do I create a trading strategy with Bollinger Bands® and moving averages?

    Learn more about how to identify buy and sell trading signals when implementing a moving average crossover strategy with ... Read Answer >>
Trading Center