# Trade Signals: How They Guide Buy and Sell Decisions

![A stock trader on the floor of the stock exchange signaling a trade based on current stock prices.](https://www.investopedia.com/thmb/dVUiCCN95wU8dEyWCNcN5mWEM7g=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/TradeSignal-7ab527c75d204712aebc9b7a9bc27d4d.jpg)

*— Jonathan Kirn / Getty Images*

> **Definition**
>
> A trade signal is a trigger to buy or sell a security and is generated by various analyses, such as technical indicators and mathematical algorithms.

## What Is a Trade Signal?

A trade signal indicates an opportunity to either buy or sell a security or other asset, generated by analysis. That analysis can be human-generated using [technical indicators](https://www.investopedia.com/terms/t/technicalindicator.asp) or generated using mathematical [algorithms](https://www.investopedia.com/terms/a/algorithm.asp) based on market action, possibly in combination with other market factors, such as economic indicators.

Trade signals can also indicate periods when portfolios and asset classes might need to be adjusted or reallocated.

### Key Takeaways

*   Trade signals are triggers to buy or sell securities based on technical indicators or algorithms.
*   They can modify portfolios by shifting sector allocations or adjusting asset class investments.
*   Simplicity in trade signals is key to managing market changes efficiently.
*   Signals can be based on technical patterns, volume surges, interest rates, and market cycles.
*   Complex signals may become obsolete quickly due to evolving market conditions.  
    

## The Mechanics of Trade Signals

Trade signals can use a variety of inputs from several disciplines. Typically, [technical analysis](https://www.investopedia.com/terms/t/technicalanalysis.asp) is a major component, but fundamental analysis, [quantitative analysis](https://www.investopedia.com/terms/q/quantitativeanalysis.asp), and economics may also be inputs, as well as sentiment measures and even signals from other trade signal systems. The goal is to provide investors and traders with an emotion-free, mechanical method to buy or sell assets.

Trade signals not only trigger buying and selling but also help modify a portfolio, like buying more technology stocks and reducing consumer staples. Bond traders can use signals to adjust their portfolio duration by selling one [maturity](https://www.investopedia.com/terms/m/maturity.asp) and buying another. Finally, it can also help with [asset class](https://www.investopedia.com/terms/a/assetclasses.asp) allocation, such as shifting money among stocks, bonds, and gold.

Trade signals can be very complex, but [traders](https://www.investopedia.com/terms/t/trader.asp) often prefer simplicity by using only a few inputs. It's easier to manage a simple signal generator and test it periodically for needed adjustments or replacements.

Too many inputs add complexity, requiring more time than traders often have. Markets change quickly, so complex strategies can become obsolete even before testing is complete.

## Trade Signal in Action

Trade signals tend to be associated with quick in and out trading. However, in reality, some signals are less frequent and based on reversion and [dip-buying](https://www.investopedia.com/terms/b/buy-the-dips.asp) in equities.

Great trading signals of this sort would be to look for periods where price action doesn't line up with the underlying [fundamentals](https://www.investopedia.com/terms/f/fundamentals.asp). An example would be if the market is selling off due to fear headlines, but the fundamental data indicates good [health](https://www.investopedia.com/terms/f/financial-health.asp). Traders may decide to buy the dip if their signal is flashing "good deal."

## How to Develop Your Own Trade Signals

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-to-earnings ratio](https://www.investopedia.com/terms/p/price-earningsratio.asp) (P/E ratio), buy when a certain technical formation breaks out to the upside, and prices are above a certain [moving average](https://www.investopedia.com/terms/m/movingaverage.asp) while interest rates are falling."

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

*   [Technical pattern](https://www.investopedia.com/terms/p/pattern.asp) breakout or break down. These can include [triangles](https://www.investopedia.com/terms/t/triangle.asp), rectangles, head-and-shoulders, and trendlines.
*   [Moving average](https://www.investopedia.com/terms/m/movingaverage.asp) 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](https://www.investopedia.com/terms/v/volume.asp) surge. Unusually high volume is often a precursor to a new move in the market. In the futures markets, [open interest](https://www.investopedia.com/terms/o/openinterest.asp) can also be used.
*   [Interest rates](https://www.investopedia.com/terms/i/interestrate.asp). Changes in rates can often suggest changes in stock and commodity markets.
*   [Volatility](https://www.investopedia.com/terms/v/volatility.asp). There are many ways to measure volatility and, as with other indicators, extreme highs or lows in volatility can trigger market changes.
*   [Cycles](https://www.investopedia.com/terms/m/market_cycles.asp). 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](https://www.investopedia.com/terms/s/sell-in-may-and-go-away.asp)—which could help determine if a strategy is operating in the strong or weak half of the year.
*   [Sentiment](https://www.investopedia.com/terms/m/marketsentiment.asp) extremes. Used as a [contrarian indicator](https://www.investopedia.com/terms/c/contrarian.asp), excessive bullishness according to surveys or actual trading activity can suggest market tops. Conversely, excessive bearishness can lead to market bottoms.
*   [Valuation](https://www.investopedia.com/terms/v/valuation.asp). An excessively high valuation compared to market, sector, or stock-specific measures can lead to sell signals.

## The Bottom Line

Trade signals are crucial tools used by investors and traders to make informed buy or sell decisions in the financial markets. Traders use technical indicators or mathematical algorithms to create signals. There are many complex signals used by traders, but simple signals are often more effective for making timely and informed trading decisions. Trade signal inputs include technical analysis, fundamental analysis, and market sentiment, providing a vast array of strategies for traders.

  
Trade signals provide traders opportunities to adjust their portfolios, shift their sector allocations, or take new positions based on predetermined criteria. However, markets move quickly and unpredictably, so it's essential for traders to periodically evaluate and adjust their trade signals to adapt to changing market conditions.

While trade signals can enhance trading strategies, it's essential to note that they should be used in conjunction with thorough market analysis and due diligence—they should not replace it.