teach me to trade
Stock trading signals and how to handle failed signals
Stock trading signals among the tools that you would use to implement a trading system or plan. Your system should be so designed that a signal is generated when all your buying or selling criteria are fulfilled. Signals have a close relationship with technical analysis because they revolve entirely around price action and price is one of the fundamental pillars of technical analysis. There are many different methods of generating signals such as moving averages and MACD. Timing is critical to profitability and effective methods of generating signals can make all the difference between profits and losses.
The advantage of using signals to decide your timing for entry and exit is that you can be decisive and objective about your investment decisions. It is by no means uncommon for traders to be afflicted by what is called paralysis by analysis which causes them to be ambivalent about when to buy and sell. Signals also eliminate all emotions and preconceived notions from your investment decisions because they are based on objective and measurable criteria. It is important that your trading system provide clear signals about when to buy and when to sell.
Even the best traders occasionally make mistakes and some of them regard the signal that has failed as the most reliable. I am sure that you have at some time made a trade that looks like the trade that cannot lose because it meets all of the textbook conditions. All your research and indicators tell you that this is the perfect investment. However, after you buy, the stock suddenly tanks and leaves you licking your wounds. You have just stepped into what market insiders call “the bull trap”.
It happens when a technical buy signal is generated and price rises because many other people in the market are watching this signal just as you are and jump in along with you to buy. Sometimes, what actually happens is that the price rise attracts buyers but not in sufficient quantities to continue the momentum. As the stock runs out of steam, the price starts to drop and triggers in a number of stop losses along the way. This accentuates the selling pressure and forces prices to decline even further. Only when the selling pressure eases will the stock price start to find some stability.
As you would have guessed, the bear trap is exactly the opposite and affects people with short positions as opposed to people with long positions. Shorting the stock will increase the upward pressure on price as stop loss positions are squared and traders cover themselves. The resulting bullish trend will result in losses for short sellers.
Now you can see why failed signals are reliable. Instead of simply closing the trade and retreating from the market, you can cut your losses by switching your investment to the other side of the trade. This will save you the trouble of looking for another trade and executing the trade on the information that you already possess. Sometimes, a failed signal can result in a trade with a high probability of success.