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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. I have put together for you the 3 key points to remember about trading signals.
- Trading signals are triggers to buy or sell a security based on a pre-determined set of criteria.
- They can also be used to reconstitute a portfolio and shift sector allocations or take new positions.
- Traders can create trading signals using a variety of criteria. From simple ones, such as earnings reports and volume surge, to more complex signals that are derived using existing signals.
How a Trade Signal Works
Trade signals can use a variety of inputs from several disciplines. Typically, technical analysis is a major component. But fundamental analysis may also be inputs, as well as 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 also 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, meanwhile, could have signals for adjusting the duration of their portfolios by selling one maturity and buying a different maturity. Finally, it can also help with asset class allocation, such as shifting money among stocks, cryptocurrencies, 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.