by Amanda Harvey
Buy signals can be defined as conditions or events that alert a trader to a potentially advantageous time for purchasing a security. These signals may be perceived simply by observing the movement of market prices and volume. The legendary trader, Jesse Livermore, used simple price data to determine his entry into a trade, and looked for what he called pivotal points as a primary indication of a signal to buy. Signals can also be gathered by using trading tools such as charts and indicators.
Jesse Livermore’s Pivotal Points
Livermore would study price movement to determine what he called pivotal points. These are points at which a price is likely to move significantly either in a reverse direction or in continuation. Livermore defined these points as the reaching for a second or third time of the same high or low price point, depending on which way the price was moving. For example, if a price was moving downward from a high of $1.00 and then reached a low of $0.80 before rising again to $0.90, if the price dropped again to the low of $0.80, Livermore would class this as a pivotal point. He would then watch to see which direction the price moved after this point, and after ascertaining the direction by waiting for movement of a few cents, would trade in the direction of the movement.
Using Indicators to Obtain Signals to Buy
One popular indicator for generating buy signals is the MACD or Moving Average Convergence Divergence. The MACD is calculated using two different moving averages - a 12-period exponential moving average (EMA) and a 26-period EMA. The result of this calculation is plotted on a chart as a single line representing the MACD. A further line known as the MACD Signal Line, a 9-period EMA of the MACD, is also graphed on the chart. The MACD Indicator provides crossover signals which pinpoint opportunities to buy.
One type of crossover signal to buy is given when the MACD Line crosses upward through the zero line. Another signal to buy is presented when the MACD Line forms an upward crossover through the MACD Signal Line.
Another indicator which effectively provides signals to enter a trade is the Relative Strength Index or RSI. The RSI is classed as a momentum oscillator, and gauges the speed and extent of directional price movements. The RSI is shown as a line on a chart which also displays levels at which the security is deemed to be overbought or oversold. When the RSI crosses above the oversold line, this is deemed a signal to buy.
Buy Signals from Chart Patterns
There are literally dozens of chart patterns, and the key to using them effectively is being able to recognize certain patterns. Once the pattern has been identified, the trader can look for the point in the pattern which constitutes a buy signal. The two main classes of chart patterns are reversal patterns and continuation patterns.
With a continuation pattern, a point close to the completion of the pattern provides a signal to buy in the direction of the prevailing trend. With a reversal pattern, the point at which the pattern is nearing completion may offer a signal to close a position that is trading with the trend, and also an indication to enter a position is the opposite direction.
Whether a trader obtains buy signals by using chart patterns or indicators, or simply studying the price movement of the market, identifying the best opportunities to enter a trade is clearly one of the most important aspects of successful trading. It is, in fact, advisable to use a combination of these methods, and to seek confirmation of an apparent buy signal before entering a trade.