How To Use Trend Analysis

How often how have you heard the term Trend Analysis? Well investors who deal with stocks are familiar with the term. Trend Analysis is a technique used in technical analysis that helps in predicting the future stock movements based on recently observed trend data.

Trend analysis uses Historical data to predict the movements. Trend Analysis helps in comparing business against other business to establish benchmark.  Trend Analysis involves collecting the information from multiple periods and plotting the collected information on a horizontal line.

Let us understanding the meaning of Technical Analysis and Trend Analysis

What is Technical Analysis?

Technical Analysis is a method to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity. This includes price movements and volume.

What is Trend Analysis?

• Trend Analysis is a technique used to predict future stock price movements. Trend Analysis is a methodology used in research to gather and study data for predicting future behavior of stocks. Share prices usually move upwards or downwards based on market sentiments.
• They never move in straight line as stock prices can be subject to high volatility in short term. By using historical data investors can try to predict whether the sector is expanding and would continue to grow or not.
• Trend Analysis involves analyzing data. It helps in comparing the performance of a firm in order to provide investors with an idea of whether the business will grow or not. It is also known as Horizontal Analysis.

Understanding Trend Analysis

• Trend Analysis predicts a trend such as bull market run. Trend Analysis is helpful because analyzing it can bring profit to the investor. It is the idea based on which traders can understand what has happened in the past. A trend is a general direction the market is taking during a specified period of time.
• Trends can be both upward or downward depending upon the bullish or bearish market respectively. There is no specified minimum amount of time required for a direction to be considered a trend.

Types of Trend

1. Upward Trend

• Upward Trend also known as Bull Market is a period when all the prices are rising in the security market. Upward Trend are seen as a sign of economic strength and can be driven by factors such as strong demand, favorable economic conditions.
• If there is an uptrend, both the troughs and the peaks of a chart will increase. Thus within a period of time, the price of the stock will touch heights and fall lower in comparison to previous price. The rise in the market is in favorable position. This way you can expect stock to appreciate.
• Whenever the direction movement moves higher highs and better lows it is often said a Silver Chart Uptrend. Consecutive peaks above the previous peaks are called higher highs and bottom above the previous peak are termed as Higher Lows.

2. Downward Trend

• A downtrend is one such pattern where the stock falls consistently and in this trend along with the successive peaks successive troughs are lower. This simply means that the investors expect the stock to fall even further. 
• A downward trend is known as a bear market is a period where the prices fall in a particular security or market. Downward Trends are generally seen as a sign of economic weakness and can be driven by factors such as weak demand, declining profits, and unfavorable economic conditions.
• A Downtrend represents the movement of a stock towards a lower price from its previous state. It will exist as long as there is lower highs or lower lows in the stock chart. The downward trend is reversed once the conditions are no longer met. After a sustained period of a downtrend the market may reverse back to an uptrend.
• The downtrend and uptrend cycles keep on fluctuating and the timing of each occurrence is always different. As the length and duration of a downtrend may vary, trends can trade a downtrend through a weekly, monthly or even in one minute.

3. Horizontal Trend or Sideways Trend

• A Horizontal Trend or Sideways Trend occurs when the prices of stocks or shares or assets are not moving dramatically upward or downward and are relatively consistent. Investors may find challenging to determine the direction of this trend. Professionals may be unable to forecast the short term or long term occurrences in the market.

How to Perform a Trend Analysis

• In order to analyze trends, it is necessary to first determine the correct market segment. For instance focus on a particular industry such as automobiles or pharmaceutical or one type of investment for example bond market.
• Once the sector is selected it is possible to examine its general performance. This includes how sectors are influenced by internal and external forces. For example changes in industrial policies or government regulations could be the major reasons for fluctuations in the market. Analysts then take these data and attempt to predict the market direction.

Trend Trading Strategies

Trend Traders attempts to attract profits from trends. There are many different trend trading strategies using below technical indicators

1. Moving Averages

• Moving Averages finds the average price of an asset over a given time frame. It creates a smooth effect on the price data producing a single line that helps the traders identify trends. There are many popular choices such as the 50-day and 200-day moving averages but ultimately the choice will depend on the individual.
• Moving averages are lagging indicators which moves slower than the market price. This means moving average cannot tell us about the future but can help us with what has happened previously. They are very useful for trend traders as the direction of moving averages can help confirm whether the market is moving up, down or sideways.
• While looking at a single moving average, a trader should focus on whether the price is above or below the moving average. If the price is above the moving average it is indicative of an uptrend and if the price is below the moving average it is an indication of a downtrend. However a common moving average strategy is to look for crossovers between two moving averages.
• Normally these are called Exponential Moving Average , one is fast moving EMA and one slow moving EMA. A trader should enter in to a long position when the EMA crosses the slow EMA from below and enter a short position when the fast EMA crosses the slow EMA from above.

2. Relative Strength Index Trend Indicator

• The relative strength index is used to identify momentum in prices. It does so by looking at the average gains and losses over a certain number of periods and ascertaining more price movements were positive or negative.
• The RSI is presented as a percentage which usually fluctuates between 0 and 100. When the indicator moves above 70, the market is considered overbought and when it is below 30, the market is considered oversold. These levels are used by traders as signals that the trend might be reaching its maturity.
• It should be noted that the market can remain overbought or over sold for extended period of time. The RSI is not necessarily a signal for an immediate change in trend because although the RSI only fluctuates between 0 and 100, the market price can range over a much larger set of values.
• Usually though a trend trader in a long position will use the overbought signal as a price point at which they can lock in their profit and exit the trade. While the trader who is willing to open short position would use the overbought signal as an entry point.
• Trend Traders utilizing the oversold signal would do the reverse, using the oversold signal as the point at which to exit short trades and open long trades.

3. Average Directional Index (ADX) trend indicator

• The average directional index is used by traders to check or determine the strength of a trend whether this is up or down. The ADX line fluctuates on a scale from 0 to 100. Values from 25 to 100 indicate a strong trend with the strength increasing as the numbers get higher, while values below 25 indicate a weak trend.
• The ADX is often plotted in the same window as the directional movement index, which is comprised of two other lines, the negative indicator and the positive directional indicator. While the ADX line identifies the strength of the trend, the other two lines determines its directions.

Examples of Trend Trading Strategies

• Let us imagine a Company A wants to study Trends related to Revenue and the Cost of Goods Sold for the last few years. Horizontal analysis of their income statements can help company A identify potentially significant patterns in the data, including evidence of fraud or accounting mistakes.
• The horizontal analysis of income statements tends to use % change but you can use other metrics depending on the focus and purpose of the analysis.
• Based on any interesting patterns you find, you can analyze them in more detail using additional data and visualizations. For instance, you might want to look at the monthly statements for a particular year if you see a peak or dip in that year that concerns you.

Trend Analysis Formula

Change in Amount = Current Year Amount- Base Year Amount

Percentage Change= Current Year Amount – Base Year Amount/ Base Year Amount

• The Term “Trend Analysis” is one of the most useful analytics tools employed for the financial analysis of statements such as income statements, balance sheets, and cash flow statements. In other words trend analysis compares the movement in each line items across time periods. It basically indicates the change either in terms of amount or as a percentage change year on year (Y-O-Y).

What are the Advantages of Trend Analysis?

1. Possibility of making Inter Firm Comparison

Trend analysis helps the analyst to make a proper comparison between two or more firms. It can also be compared with industry average.  That is it helps to understand the strength or weakness of a particular firm in comparison with other related firm in the industry.

2. Usefulness

Trend analysis is found to be more effective in comparison with the absolute figures on the basis of which the management can take the decisions.

3. Useful for Comparative Analysis

Trend Analysis is very useful for comparative analysis of date in order to measure the financial performances of firm over a period of time and which helps the management to take decisions for the future.

4. Measuring Liquidity and Solvency

Trend Analysis helps the analyst and the management to understand the short term liquidity position as well as the long term solvency position of the firm over the years with the help of related financial trend ratios.

5. Measuring Profitability Position

Trend Analysis also helps to measure the profitability positions of an enterprise or  a firm over the years with the help of some related financial trend ratios.

Disadvantages of Trend Analysis

1. Selection of Base Year

It is not so easy to select the base year. Usually a normal year is taken as base year. But it is very difficult to select such a base year for the purpose ascertaining the trend. Otherwise comparison or trend analysis will be of no value.

2. Consistency

It is very difficult to follow a consistent accounting principle and policy when the trends of business accounting are constantly changing.

3. Useless in Inflationary Situations

Analysis of trend percentage is useless at the time of price-level change. Trends of data which are token for comparison will present a misleading result.

Conclusion

Trend Analysis is thus a study of data to identify patterns or trends that can be used to make good investment decisions. This type of analysis is used to analyze the performance of a particular security such as stock or bond over a given period of time. There are several methods involved in technical analysis like using charts, graphical tools to identify patterns in price and volume data and fundamental analysis which focuses on a company’s financial health. Trend analysis thus incorporate a variety of data sources, including price charts, financial statements, economic indicators and market data.