Unraveling Trading Signals: A Practical Guide
by Robert Buran
Interpretations of Trading Signals
In the world of trading, the term ‘trading signals’ can conjure different images depending on whom you ask. A steadfast contrarian might equate a trading signal to sell stocks with the presence of a bull on the cover of Time Magazine. In contrast, a committed technical analyst may scrutinize particular stochastic figures on a 30-minute bar chart to determine the perfect time to buy a particular stock. On the other end of the spectrum, a dedicated fundamental investor might perceive specific financial metrics of the underlying company as a signal.
Establishing a Usable Definition of Trading Signals
Despite the varying interpretations, I’d like to introduce a functional and practical definition of a trading signal. Let’s explore an instance of a trading signal that I find beneficial in navigating the trading terrain.
Consider any stock and review all the daily bars for the previous 10 days. Proceed by subtracting all the highs from the corresponding lows to obtain the daily ranges for each of these 10 daily bars. Now, compute the average range for these ten days, terming it the Average Daily Range. Subsequently, divide each daily range by two to derive the midpoint for each day. Following this, find the average midpoint for these 10 days, dubbing it the Average Midpoint. Then, add 125% of the Average Daily Range to the Average Midpoint to ascertain our trading signal to buy the next day.
In essence, we have generated a signal utilizing just two variables: Average Daily Range and Average Midpoint.
Constructing a Trading Signal Exit
The ways to exit this trade are numerous, but our goal is to maintain simplicity and restrict our parameters. We might want to set a stop loss on the average low and capitalize on profits at the average high plus 150% of the Average Daily Range.
Utilizing Market Momentum Theory in Trading Signals
Drawing from the simplest ideas of market momentum theory and using the most minimal parameters, we’ve created signals. This modest trading system could likely tame the capriciousness of short-term stock market movements and potentially generate some profit. For an in-depth understanding of these concepts, refer to my articles on market momentum theory in ‘Stock Market Basics: Dummies Can Be Winners Too’ and ‘A Fresh Approach to Debunking Stock Trading Myths: Unraveling the Mystery of Price Movements.’
Essential Characteristics of a Trading Signal
While the goal of this article is not to design a trading system, it is to shed light on my perspective on what constitutes a valid trading signal. In my viewpoint, a trading signal should encompass the following traits:
- A trading signal must be mathematically precise and definite.
- It should be programmable into a computer, enabling the computer, not the trader, to track the relevant markets and alert the trader when the trading signal has been activated. This feature permits the trader to diversify and to trade multiple markets concurrently.
- Lastly, the trading signal must be versatile enough to be tested in various market types and different market environments to affirm its accuracy and validity.
When used in this context, objective trading signals become the pillar of our trading system development and evolve into indispensable tools for profitable stock trading.
Implementing Trading Signals in Real-Time Trading
To better understand the application of these trading signals, check out JORDI FUSION—a trading system I’ve used for over a decade in real time, which utilizes trading signals analogous to the hypothetical ones discussed above. The rules outlined in this article influenced the design of JORDI FUSION. For more insight, you can download my real-time performance of JORDI FUSION from the Home Page of this site. Additionally, I post a daily video of my trading experiences using these signals on the Home Page.
Embarking on the journey of finding the right trading signals can be challenging but rewarding. Good luck with your quest!