What does a buy signal look like?

A buy signal should show up at a market bottom, or close to the bottom, and be the opposite of a sell signal. But how can a market bottom, or top for that matter, be determined? The fact is no one can pick tops or bottoms try as they may. Just like no one can tell you what will happen tomorrow. But we can read signs in the market. Just as the weatherman makes predictions, so should we be able to make predictions by the signs in the market.

The trend is your friend until the end when it bends. Tops and bottoms occur at the end of a trend. So we should look for bends in the market for both buy and sell signals. But what is a trend and what is a bend? Very simply, a trend is a series of higher highs and higher lows in an uptrend and lower lows and lower highs in a downtrend. A sideways market is usually a period of consolidation in the larger time frame trend although it can also mark tops and bottoms when it represents a failure of the market to penetrate support or resistance.

Markets move in cycles or waves and have peaks and troughs. The peaks are the highs and the troughs are the lows. And also, a trend can be said to be “intact” so long as it does not break a trend line. So then, a bend in the trend is when we get some change in the above. A few examples will help here. Please note (my disclaimer) I am not making recommendations to buy or sell any securities.

Since the change in the long term trend must occur first in the shorter time frame lets begin by looking at a 20 day chart of 4 hour periods of the S&P500. This chart clearly shows that the fast band of moving averages has crossed over the slow band. I previously gave an introduction to this type of analysis here. A buy signal occurs when the fast band finds support on the slow band. A sell signal occurs when the fast band finds resistance at the slow band. For a change in the trend to occur, what we have called a bend in the trend, the fast band must cross the slow band. Anytime this happens it is worthy of note. Click on chart to enlarge.
If we look at the shorter time frame, the 4 hr chart above, this change will occur before it occur in the longer time frame such as the daily charts below. The 1 month daily chart show that the moving averages have not crossed on this time frame.

A 3 month daily chart shows us the last time the fast band crossed the slow band.

A 6 month daily chart gives us an even better view and shows the top of the market back in October.

In conclusion, the shorter time frame we have used here, the 4 hr time frame on the first chart above, can be used to give a heads up signal for the daily time frame. If a person trades according to the daily time frame this will give fair warning of a trend change. The same idea can be applied if a person makes trades according to a weekly chart.