Chapter 03

Trading Signals & Indicators

Raw data is noise. Signals are the patterns within that noise that give you an edge. This chapter covers the most important quantitative indicators traders use — how they work, when they fail, and how to combine them.

Moving Averages: The Foundation

A moving average smooths price data to reveal the underlying trend by averaging prices over a set number of periods.

  • Simple Moving Average (SMA): Equal weight to every period. The 50-day and 200-day SMAs are watched by virtually every trader.
  • Exponential Moving Average (EMA): More weight to recent prices. Reacts faster to current price action. The 9 and 21 EMAs are popular for short-term traders.

Key signals:

  • Golden Cross: 50-day MA crosses above 200-day MA — a long-term bullish signal.
  • Death Cross: 50-day MA crosses below 200-day MA — a long-term bearish signal.
  • Price vs. MA: Price consistently above its 20-day MA = uptrend. Below = downtrend.
Moving averages are lagging indicators — they confirm trends, they don't predict them. They work best in trending markets and get chopped up in sideways markets.

Momentum Indicators

Momentum measures the rate of price change — how fast prices are moving, not just direction.

RSI (Relative Strength Index)

RSI ranges from 0 to 100 and measures the speed and magnitude of recent price changes.

  • Above 70: Overbought — the stock has risen too fast and may pull back
  • Below 30: Oversold — the stock has fallen too fast and may bounce
  • Divergence: Price makes a new high but RSI doesn't — this signals weakening momentum and a potential reversal

MACD (Moving Average Convergence Divergence)

MACD tracks the relationship between two EMAs (typically 12 and 26 period). It consists of:

  • MACD line: 12 EMA minus 26 EMA
  • Signal line: 9-period EMA of the MACD line
  • Histogram: Difference between the two — shows momentum acceleration

When the MACD line crosses above the signal line, it's bullish. When the histogram grows, momentum is accelerating.

Volatility-Based Signals

Bollinger Bands

A 20-period SMA with bands plotted 2 standard deviations above and below. The bands expand in high volatility and contract in low volatility.

  • Band squeeze: When bands contract tightly, a big move is coming — you just don't know which direction
  • Touch the upper band: In a trend, this is bullish. In a range, it's overbought.
  • Touch the lower band: In a trend, this is bearish. In a range, it's oversold.

ATR (Average True Range)

ATR measures the average daily price range. It doesn't tell you direction, but it tells you how much a stock typically moves — which is critical for setting stop losses and position sizes.

A stock with ATR of $2.50 typically swings $2.50 per day. Setting a stop loss tighter than 1 ATR means you'll get stopped out by normal noise.

Volume-Based Signals

  • Volume Price Trend (VPT): Combines price change and volume to confirm trend strength. Rising price with rising VPT = healthy trend.
  • On-Balance Volume (OBV): Running total of volume: adds volume on up days, subtracts on down days. OBV trending up while price is flat = accumulation (bullish).
  • VWAP (Volume Weighted Average Price): The average price weighted by volume. Institutional traders use VWAP as a benchmark. Price above VWAP = buyers in control.

Combining Signals: The Multi-Factor Approach

No single indicator is reliable alone. Professional quant traders combine multiple uncorrelated signals to build confidence:

  • Trend + Momentum + Volume: Price above 50 MA (trend) + RSI rising from 40 (momentum) + volume above average (conviction) = high-probability long setup.
  • Mean reversion + Volatility: RSI below 20 (oversold) + price at lower Bollinger Band + ATR expanding = potential bounce trade.
  • Breakout + Flow: Price breaks key resistance + volume surges 3x average + dark pool prints at the ask = institutional breakout.
The best quant setups occur when multiple independent signals align. One indicator is a suggestion. Three confirming indicators is a trade.

Common Mistakes

  • Indicator overload: Using 10 indicators doesn't make you 10x smarter. Many indicators are correlated and just add noise.
  • Ignoring context: An RSI of 70 in a raging bull trend doesn't mean “sell.” Indicators must be read in context.
  • Curve fitting: Finding the perfect indicator settings for past data doesn't mean they'll work going forward.
  • No stop loss: Every signal fails sometimes. The question is how much you lose when it does.