Stock Signals

Recognize stock signals – the best methods for more profit

Recognizing stock signals is not always easy. And signals are not equal to stock trades. What may surprise many right at the beginning is as much a fact as the fact that some signals are not real signals at all. And therefore do not bring a crucial advantage.

In Billions, my Elite Trading Club, I show what the differences between a signal and a trader are live several times a week. Here in this article we will now work out the subtleties and talk about the topic of recognizing stock signals in detail.

Signal – what are we actually trading?

When we traders start a trade, or as it is called in the new German language, make an entry, we need a reason for it.

This general formulation is a good guide to what trading is all about. Because you should never start a trade on a whim or at random, when the entry is by far the most important part of a good trading strategy.

Of course, other components such as the exit or the choice of the right position size are also crucial. But the fact is that while a bad exit can ruin a lot, the best exit hardly brings any additional performance boost if you get into the car in a well chosen way.

However, this can only be seen if you do intensive back tests, which will certainly be reserved for very ambitious traders (what a pity!). But back to the topic of recognizing stock signals.

An entry signal is a trigger

When we start a trade, we take advantage of good opportunities that – from a statistical point of view – increase our chances of the trade succeeding. Although the hit rate (number of losses – trades to the winners) is much less important on the bottom line than a prospective trader might think, it is of course important that I only act when the chances are good.

But when is that guaranteed? When are the chances good? In order to make a good entry, something must have happened that increases the probability that a trade will work. When that is, we will discuss that in a moment.

A signal is triggered by an effect

A trading signal pops up when something has happened. In relation to the stock exchange and trading, this naturally means that there has been a certain type of price movement before the entry.

So there must be a certain pattern in the quotes. If something is clearly recognizable, you can usually measure it. Which brings us to the next topic to better understand the challenge of “recognizing stock signals”.

A good signal can be duplicated

Of course one is pleased about high single – profits. But a good trading system produces surprisingly few high single wins. Rather, it is designed to produce frequent trades, because this ensures a high stability (reliability) of the system.

In addition, high single profits are rare because traders are usually only positioned in a few bars (days, hours, minutes etc.). And there the trees do not grow into the sky.

From a statistical point of view, it would be unlikely if, for example, a trade on the daily chart rose by 20% within 5 or 6 days. In fact, many such trades end up with only a few percent profit or loss, and the mass of small profits makes the difference.

Therefore a trader needs a clear duplicability in his signals. Because a single signal does not bring a positive expectation value. However, thousands of signals distributed over several decades do.

What does duplicability mean?

Many traders do not take duplicability so seriously. But this is the only way to recognize clear stock signals. We will now explain this and look at some examples.

If I buy Apple because I think that the stock has become cheap enough, it is not duplicable. Don’t get it wrong: it can work, but it is not repeatable. Of course I can buy Facebook, Google or Tesla if I agree. But there is still no clear repeatability. Hard facts that are 100% applicable and measurable over and over again are missing. Instead, I build my trade on faith and hope.

If I buy Apple because I see a hammer (a certain candlestick formation) in the chart, this is not duplicable either. Why? Because the definition of a hammer is roughly available, but not exactly defined.

Where one trader just sees a hammer, another does not see it. Therefore, we cannot test most candlestick patterns for their suitability, because they are simply afflicted with a certain margin of interpretation. And this latitude can make a big difference in practice.

If I buy Apple because I see an upward trend and draw a trend channel, a backtest is just as difficult. Today, I can certainly backtest trend lines with modern programs and thus check their suitability. But still, the question remains, where I can exactly lean the trend line. Here we have a borderline case that can be tested “somehow” but ultimately not exactly (enough).

But if I buy Apple now, because the share has risen by 2% in the last 5 days and I want to follow the trend and enter the market for a long time, then we have reached a 100% duplicability. There is nothing to shake around or interpret differently. 2% in 5 days is 2% in 5 days. If it is only 1.9% in 5 days, no signal is emitted. The same applies to other indicators with clear thresholds and retrospective periods.

Any duplicable market behavior, if it works for Apple, I can now test for Facebook stock. Or with Google. Or with all shares of the S&P 500. If this works (makes a profit), I have probably found a good entry logic.

But for this I have to make the effort to internalize the basics of baking testing. Because if I base my decisions on faith and hope, I will never know if what I do makes sense.

So I make an entry when there is a market behavior that I have examined and that I know is worth it. Only then do I get a signal and start a trade. Good – now I am positioned. But when do I end the trade? When do I go out again? We will talk about this in the next paragraph.

Exits are also signals

When we talk about recognizing stock signals, the question is usually when to enter the market. But when we get out is also a signal. Namely one for the exit. So when do we get out? Basically, there are three possibilities when to exit a trade.

  1. Everything goes as planned
  2. Things are going worse than planned
  3. It is going better than planned

Let’s talk briefly about these 3 options.

Everything goes as planned

Depending on the design of the rules and regulations, a planned holding period could be applied here. For example, the trade is terminated within 6 days.

It runs worse than planned

For this case I need a worst case exit scenario. This can, but does not have to, be applied before the planned end (point 1). Here a stop loss could be applied.

It runs better than planned

If I have a basic holding period of 8 days, but the trade is already very far in the plus on day 3, it might be a good idea to take the profits early. A price target might be appropriate here.

And/or links

Of course you can add various and/or links to points 1-3. And also a complete exit logic could consist of only 2 or even just one of the above mentioned possibilities. Here you have to test and try what gives the best results.

So you see, both at the entry and at the exit I get a signal which I implement. So let’s continue with the text. What about the strength of signals?

Signal strength

Signals show effects to which I want to use, we have been so far. We already know about duplicability and that we have to trade often to make a strategy stable. But there is another reason why we have to trade frequently. And it’s all about the duration of the effect of such an entry signal. What ultimately determines our holding period.

If you look at entry signals with scientific methods, you will quickly notice that these signals become weaker and weaker the longer back in time they are. And at some point they lose their effect completely if they are too long in the past.

What sounds very abstract is actually quite simple. And this video explains it very well.

An entry signal – signal fizzles out over time. The longer we stay in the trade, the weaker it gets. We have talked about the reasons in detail in the video. So, when trading, we have no other choice than to search for new entrys frequently.

Not all signals are the same Trade

If we conclude this article on the topic of equity signals, we can now remove the hint from the introduction as to why not every signal must be a new trade. This is simply because I usually generate my signals from large portfolios when trading stocks. For example, my portfolio could be the S&P 500.

If I now trade a long only reversion system on the daily chart, which makes sense for stocks, it will produce many signals in some market phases (when the market falls for days) and few signals in some phases (when the market rises for days). If there are many signals, my position sizing is responsible for the fact that I might receive too many signals.

Too many because the number of trades is limited and/or dictated by my capital. A simple position sizing could be that I may have a maximum of 8 trades open at any one time per trading strategy. So I divide my trading capital into 8 positions. With 25,000 total trading capital, for example, EUR 3,125 would be allocated to each position.

Let’s further assume that of the 8 possible trades, I already have 6 trades running. A simple time exit after 8 days of holding time tells me that the trades have to run for another 3 days. So today I would have room for 2 new trades.

But my signal search on the S&P 500 portfolio shows me 12 new signals for today. Which of the 12 do I take if there are only 2 new trades left? Somehow I have to decide for 2 out of 12. And this is where the Position Priority comes into play, a logic with which you sort the entry signals according to a certain logic.

The Priority of the signals

How to sort the signals, there are several possibilities. If you stay on the long side in reversion systems, you could sort the signals by which stocks have fallen the most.

Or the least. Here you have many possibilities and also here a backtest will help us to find the right logic.

Conclusion Trading Signals

However they get to their stock signals. Please make sure that they are chosen wisely. Never leave anything to chance on the stock exchange. Trading is not an easy business. The trader should therefore be inclined to automate as many steps of the whole trading process as possible.

Among other things, automation means having clear rules when to buy and sell stocks and other securities. If you follow this advice, then nothing stands in the way of successful trading.

To speed up your learning progress, we invite you to take advantage of one of our free Start offers. Choose between a free trading course for beginners or a case study for advanced traders. Both offers are free of charge for you.

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