Buy Signal Confirmation

What Is a Buy Signal?

A buy signal is an event or condition selected by a trader or investor as an alert for entering a purchase order for an investment. Buy signals can be either observed by analyzing chart patterns or calculated and automated by trading systems.

For example, momentum investors may compare the relative strength of several investment choices over the last few months and select the best performing choice as a candidate to add to their portfolio in the coming month. On the other hand, short-term traders may use tools such as moving averages or other technical studies to enter a position on any given day.

Understanding Buy Signals

Buy signals may be used by short-term traders and long-term investors. For example, contrarian investors may look at a significant sell off as a buy signal since the market may have overreacted, or a value investor may look at a price below net asset value per share as a buy signal. On the other hand, a trader using an automated trading system may automatically generate buy and sell signals based on a set of rules.

Some of the most common buy signals include:

While many technical indicators generate buy signals, it's important to note that even the developers of these indicators don't advocate that anyone should blindly use these signals to automatically generate a purchase order. It is useful to confirm from a variety of sources, including technical and fundamental data, that conditions are favorable for investment or trading.

For example, a moving average crossover may generate a buy signal, but the trader may look for confirmation in the form of a breakout above a designated price level that implies increase value propositions.

Some software developers do publish and promote black box trading systems that generate buy signals for subscribers. For example, an investment research firm may generate a complex neural network that generates buy and sell signals they send to subscribers that pay a monthly fee. Traders should approach these black box models with skepticism and due diligence since past performance may not be indicative of future performance.

Example of a Buy Signal

The chart below shows an example of a buy signal generated from a moving average crossover in the SPDR S&P 500 ETF (NYSE ARCA: SPY).

Image by Sabrina Jiang © Investopedia 2021

In the chart above, a buy signal was generated when the 50-day moving average crossed above the 200-day moving average. This is an example of the well-known Golden Cross signal that is occasionally mentioned in financial media stories.