What Is a Buy Signal in Investing Common Examples
What Is a Buy Signal in Investing, Common Examples
A buy signal is an event or condition selected by a trader or investor as an alert to enter a purchase order. It can be observed by analyzing chart patterns or calculated and automated by trading systems.
For example, momentum investors compare the relative strength of investment choices over a few months to select the best performing choice for their portfolio. Short-term traders may use tools like moving averages or technical studies to enter a position.
Key Takeaways:
– Buy signals help traders and investors follow predefined patterns.
– Research the value of signals before using them.
– Be cautious of automated systems that produce black box signals.
Understanding Buy Signals
Buy signals are used by short-term traders and long-term investors. Contrarian investors may see a significant sell-off as a buy signal, while a value investor may view a price below net asset value per share as a buy signal. Traders using automated systems generate signals based on rules.
Common buy signals include:
– Chart Patterns: Buy signals are generated when the price breaks out from a certain level in chart patterns like an ascending triangle.
– Technical Indicators: Buy signals are generated when certain conditions are met in technical indicators like the relative strength index (RSI) moving below oversold conditions.
– Intrinsic Value: Buy signals occur when the price falls significantly below a trusted theoretical value calculated through discounted cash flow analysis or other techniques.
While technical indicators generate buy signals, it’s important to confirm conditions from multiple sources, including technical and fundamental data.
Some software developers create black box trading systems that generate buy signals for subscribers. Traders should approach these models with skepticism and due diligence since past performance may not indicate future performance.
Example of a Buy Signal
The chart below shows a buy signal generated from a moving average crossover in the SPDR S&P 500 ETF (NYSE ARCA: SPY).
In the chart above, a buy signal occurred when the 50-day moving average crossed above the 200-day moving average. This is an example of the Golden Cross signal occasionally mentioned in financial media stories.
