I’m seeing some confusion regarding the difference between market conditions and market signals and how to use them to guide your trading. So let’s dive into this topic.

What are market conditions?

Market conditions describe if stocks (or indices) are overbought or oversold. Either condition can last for quite some time, and in fact, stocks swing from one to the other on a regular basis.

Some traders use the readings to determine when a change in trend is coming, but as I often write, trying to time the markets is a fool’s errand. I use overbought and oversold readings to understand how a stock or the entire market looks at a certain moment, but I don’t necessarily act upon it.

A lot of traders and investors think overbought means you need to sell. It probably means a potential pullback is coming but how you act on it depends on your trading horizon. If your trading strategy is short-term, you probably want to sell and raise some cash, buy protection, and wait for conditions to return to normal. Or, if you have a long horizon, you can ignore market conditions and simply hold onto your positions.

What are market signals?

Market signals refer to readings on technical and sentiment indicators that traders use to filter through the noise and understand the stock or market trend. A signal might include a few technicals readings, like price, volume, and momentum. Or it might be a pattern that has been completed, in which the odds tend to favor a movement up or down.

Take for example an eveningstar pattern. This is a bearish, three-candle formation (green candle, doji (neither green nor red), then a red candle). If you see this pattern, it’s a signal to place a bearish trade (puts, short sale). When waiting for a pattern to fully develop, patience is a virtue! Once the pattern is confirmed, you can take action, knowing how things will play out.

Don’t use sentiment alone as a market signal. Sentiment only tells how traders and investors are feeling. It does not give you enough information to be confident about making a trade.

And yes, you can use market conditions and market signals together to trigger buying and selling. If the evidence stacks up in favor of a strong market condition and a few signals point to a bullish or bearish trend, you can feel confident placing a trade.

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