Trade Signal

Updated on April 2, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What is Trade Signal?

A trade signal is an analytical tool that provides a trader the cue to make buy or sell orders to maximize profits. Various forms of trade signals exist, with differing goals and potential profits. Traders have been using technical indicators to reduce their risk in trading for a long time.

The basis of using trade signals is to ensure that trading is not done randomly but after careful analysis to reduce losses. They can be especially helpful for day traders and individuals who use large leverages to trade. Most traders have favorite signals that they depend on, which is usually a function of their trading method.

what are trade signals

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Key Takeaways

  • Trade signal indicators provide information about the current state of the trading market and how it is bound to move.
  • Signal indicators are used by both amateur and professional traders as an aid to make maximum profits from trading.
  • Many types of signals are available, each of which looks at different aspects of the market and provides information about various actions.
  • Some of the best trade signals are Moving average convergence divergence(MACD), Simple moving average, Stochastic indicator, Exponential moving average(EMA), Relative strength index(RSI), etc.

How Does Trade Signal Work?

Trade signals can provide information on whether to enter or exit a trade and the best time to do it. The signal can combine one or more factors to form a single trigger. 

The analysis considers a variety of factors like price, volume, market sentiments, historical data, etc., to form predictions of stock market trends called technical indicators. One can opt to incorporate one or more technical indicatorsTechnical IndicatorsTechnical indicators refer to technical analysis tools used by investors to make investment decisions based on future price movements derived primarily from historical prices. read more to try and reduce the risk of making a trade. However, the resultant tool might be complex and counterproductive with too many technical indicators. 

Algorithm-based trading indicators are essentially apps or programs which analyze the market and then provide output on how to trade. It is often based on the historical movement of the market and deep mathematical analysis. Usually, third parties make trade signal apps and sell them to traders who need them. Algorithms are only as good as how people make them. So it is better to use algorithms made by people who deeply understand the factors affecting trade movements. Very well-made algorithms and trade signal apps can even consider economic indicators to advise the trader on the current state of the market and whether to go short or long on a selected stock or commodity. 

Some online trading platforms allow traders to create trade signal tools that automate trading. They do this by analyzing the market movements and only making a short or long trade based on the rules the user had instituted in the platform. It can be advantageous when the trader wants to wait for the market to be in a particular state before entering the trade. 

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Uses of Trade Signals

In addition to determining when to enter a trade, trade signals can also be used to change products in a portfolio. It comes about when the trade signal identifies products likely to yield the most profits in the short, medium, and long terms. They can also be used to switch positions depending on market variables. For example, if a trader has gone short on a specific product and the market changes such that this will lead to a loss, the trading signal can be used to turn it into a long positionLong PositionLong position denotes buying of a stock, currency or commodity in the hope that the future price will get higher from the present price. The security can be bought in the cash market or in the derivative market. The course of action suggests that the investor or the trader is expecting an upward movement of the stock from is prevailing levels.read more. This way, the trader does not have to endure massive losses. 

The bottom line is that trade signals are increasingly useful to traders today. The best trade signals can maximize profits while reducing the risk of trading. However, some simple trading indicators are best suited for beginners who trade with money they can afford to lose. This is because, as a beginner trader, one is still learning the market and how it behaves. They are also learning how the trading indicator works and how to interpret information from it.

Trade Signal Example

A trading signal can be particularly useful for a person trading on their own for the first time. Today, it is easy to trade on different platforms from home; one does not have to go to a stock market exchange floor. In this position, one can extract a large amount of information from the trade signal indicators. It includes the current state of the market, when to enter a particular trade, and when to leave the trade. It also gives insight into the probability of making profits at a specific time. 

A beginner trader could use the stochastic indicator to learn when the market is risky or favorable to trade. A stochastic indicator oscillates between 0 and 100, indicating the lowest and highest pricing in a period. The indicator compares the current price value to the maximum and minimum price to represent market movement. This signal is good at indicating whether a security is oversold or overbought. It also helps to evaluate trading risks at that time. Stochastic readings closer to 100 indicate overbought signals, and those closer to 0 indicate oversold signals.

Best Trade Signals

Trade signals are myriad, and each serves specific purposes. However, some of the most common and best trading signals are: 

#1 Moving Average Convergence Divergence

This measures both the momentum and trend of the market. MACD indicates the intensity of an upward or downward moving trend in the stock market. When the MACD line dives above the signal line, the trend is bullish, and traders are safe to buy a security. Similarly, when it dives below the signal line, it indicates a bearish trendBearish TrendBearish market refers to an opinion where the stock market is likely to go down or correct shortly. It is predicted in consideration of events that are happening or are bound to happen which would drag down the prices of the stocks in the market.read more, and the traders are safe to sell a security.

#2 Exponential Moving Average

This signal provides the average price of a security during a specific time. In doing this, it places higher priority over more recent data. Hence, many analysts consider EMAs more beneficial than simple moving averagesSimple Moving AveragesSimple moving average refers to a type of moving average, and it is derived by calculating the average of prices or values observed over a specific number of days or periods.read more as they are more sensitive to recent changes. Traders may opt for different ranges of moving averages. 

Let us look at the Bitcoin/ US Dollar chart below to understand the concept of exponential moving average better.

Source

As we can see in the above chart, the red, yellow, green, and blue lines denote the 20-period, 50-period- 100-period, and 200-period exponential moving average lines. These lines show the direction in which the price is moving. Generally, traders consider entering a long position when EMA is increasing. On the other hand, traders consider exiting a long position or entering a short position when EMA is dropping.

In this case, traders may utilize the EMAs to determine the overall trend in the market. If the shorter EMAs are above the longer ones, it is an indication of an upward or bullish trend. Accordingly, people may consider entering a long position. That said, when the longer EMAs are above the shorter ones, traders may consider utilizing short-selling strategies.

Note that traders can customize the EMA periods as well as the label sizes to match their trading preferences and style.

One may consider looking at other EMA charts to enhance their knowledge regarding this widely popular technical analysis indicator. Individuals can find the same on the official website of TradingView.

#3 Relative Strength Index

The RSI, or relative strength indicator, is also useful in trending markets and is plotted from 0 to 100. An RSI reading above 70 can represent an overbought condition, while an RSI reading of less than 30 can represent an oversold condition. Unlike MACD, the RSI examines the relationship between recent higher and lower prices. It uses the average of gains and losses over a certain period.

#4 Stochastic

This signal is key to providing information on the oversaturation or undersaturation in the market, thus allowing the trader to know what safe position to take. The stochastic indicator oscillates between two range limits, i.e., 0 and 100, which are the lowest and highest price ranges in a given period. Stochastic indicators are generally easy to read and accurate.

#5 Simple Moving Average

This is a common trend-following trading indicator that new traders use regularly. The SMA shows lagging indicators clearly and is especially useful in showing the market’s direction. The latter can sometimes not be clear when looking at real-time graphs. One of the characteristics of the SMA is that it utilizes simple moving averages to produce the output.

#6 Client Sentiment

This is as a contrarian indicator. This signal tells about the trader’s collective sentiments towards specific markets to sell in an upward market condition and buy in a falling market condition. The changes in sentiments and the direction they are leaning towards are a good addition to the price analysis. It is especially useful in trending markets and is relatively easy to use.

Frequently Asked Questions (FAQs)

What are trade signals?

Trade signals are analysis tools that tell a trader whether to buy or sell security depending on the technical analysis of the market. They signal the trader to make stock market decisions using mathematical analysis of all the available data.

How to use trade signals?

Trade signals can use a range of inputs like price, volume, market sentiments, past trading, etc., to calculate and give predictions of market trends. The traders can use this analytical tool to make clever investment decisions that can bring them maximum profits.

Are trade signals worth it?

Trade signals provide the traders with a large amount of information regarding stock market trends. They give easy, accurate, and solid indicators for making investment decisions on the market. They are highly helpful tools for someone looking to generate maximum profits in the stock market with fewer risks. 

This has been a guide to what is trade signal and its definition. Here we explain how it works along with examples, uses, and best indicators. You may learn more about financing from the following articles –