Trend Analysis is a statistical tool that helps to determine the future movements of a variable on the basis of its historical trends. In simple words, it predicts future behavior on the basis of past data. Under this method, a researcher collects information from multiple time periods and plots the information on a horizontal line to get some meaningful information. There is no specific amount of time for a movement to become a trend. However, the longer the movement, the better it is.
Trend Analysis and Stock Price
In finance, trend analysis is a technique to determine the future movement of a stock. It is a part of technical analysis and predicts the stock movement on the basis of past performance.
The primary objective of using this technical analysis is to locate potential investment opportunities. A trend can be both upward and downward. Thus, studying it also helps to determine the exit point of the current stock so that investors don’t lose money.
For example, an analyst finds that a stock has risen by 0.02% daily for the last five days. Also, previously when the stock rose this much, the trend continued for more than two months. On the basis of this, the analyst will suggest investors to buy the stock now and exit two months after.
Along with using this technical analysis to maximize the potential for profits, an analyst can use it to understand the factors that may affect the value of the stock irrespective of general market conditions. For this, the analyst will also need to study the company’s market and technologies, competition, and financial conditions.
Types of Trend
It is the trend when financial markets and assets move in upward directions, resulting in an increase in the price. It is usually the time of boom in the economy, where overall sentiments are favorable.
In the downtrend or the bear market, the economy, financial markets, and assets prices move in a downward direction. It is the time when companies shrink operations, and overall investor sentiment is not favorable.
Sideways / horizontal Trend
In this, the assets prices or the broader economy-level are not moving in any direction, rather are moving sideways. This means moving up for some time and then down on the same level. It is a risky movement as investors are unsure of what will happen to their investments.
How to Do a Trend Analysis?
First, determine the sector or industry or company or investment that needs to be analyzed, such as auto, pharma, or a bond market.
After selecting the sector, it is possible to examine its general performance. For this, one needs to study the internal and external forces affecting the sector, like changes in technology, any new governmental regulation, or more.
Now, an analyst must use this data to predict the future direction of the item they chose.
Common Trend Trading Strategies
There are several trend strategies or we can indicators that provide trade signals or warn of reverse movement. Following are the strategies or trading signals that analysts use the most:
In this, one can enter long positions when the short-term moving average goes above the long-term moving average. On the other hand, when the short-term moving average goes below the long-term moving average, one enters a short position.
Trendlines & Chart Patterns
Using this strategy, one enters a long position when the trend line moves up. Don’t forget to put a stop-loss below key trendline support levels when initiating such positions.
Under this, one enters a long position when a stock shows strong momentum. Usually, the analyst uses the relative strength index (RSI) to gauge momentum.
Revenue and Cost Analysis
Apart from predicting stock movement, trend analysis is also useful for revenue and cost analysis. An analyst can plot a company’s revenue and cost information from multiple periods over a trend line. After that, the analyst can use this information to identify trends and inconsistencies.
For instance, if revenue for a company rises in one quarter and drops in the other for the past many years. This may indicate seasonality in demand for the product that the company sells. On the other hand, one can use it to identify any error. For instance, a deviation of the current trend from the past may require an analyst to investigate the cause. This may result in analysts finding some errors in accounting.
Read more on Methods of Financial Analysis.
So, management can use this type of analysis for:
- Analyzing revenue trends to check if the sales are rising or dropping for certain products, customers, and regions.
- Examining the expenses report tracing fraudulent claims, if any.
- One can also use it for budgeting purposes by extending the revenue and expense line items.
One major disadvantage of trend analysis is that it is not 100% accurate. Or, we can say past behavior is not always indicative of the future. This is because several factors affect the price of the security (or revenue and expense), and these factors change over time. Also, critics of such a method argue that markets are efficient, and the stock price already reflects all available information. This means that history won’t repeat itself. Thus, it is always advisable to support technical analysis with extensive research to make a better prediction.
Trend analysis is one of the most popular ways that analysts over the world use to determine the movement of a security. However, it is not an easy task and requires eyes on detail and a thorough understanding of the market. Also, depending solely on trend analysis could prove dangerous. Thus, one must complement it with a proper analysis of the past and current events.