Trend Analysis

5paisa Research Team

Last Updated: 19 Sep, 2022 06:11 PM IST

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Introduction

A technical analysis technique, trend analysis is an approach that predicts a company's stock's future price movements by observing its recent trend data. The analysis uses historical data points on price movements and trade volume to forecast the market sentiment direction in the long term. 

What Is Trend Analysis?

Technical analysis is an approach for evaluating investments and identifying trading opportunities. It analyses statistical data gathered from trading activities such as historical price movements and trading volume. Trend analysis in the stock market is a technical analysis technique. 

Traders use the trend analysis strategy to construct future predictions based on historical data points. It involves comparing data points over a specific period and identifying upward, downward, and stagnant trends. The analysis focuses on three time horizons - short, intermediate, and long term.

A trend is a general direction the market takes over a specific period. The direction of the trend can be upward, bullish, or downward relating to bearish markets respectively.  No minimum period is required to determine a direction as a trend. The longer it is maintained, the more notable the trend is considered.

Analysing trends is considered a form of comparative analysis, where current observation predicts future ones. The analysis determines whether a current market trend, such as gains in a particular market sector, will continue. It can also determine whether a trend in one area of the market can create a trend in another.  Although market trend analysis works on a large amount of data, it does not guarantee the results to be correct.

A stable and steady trend over some time indicates consistency and invokes more certainty. Although, investors who analyse frequent trend changes tend to find inconsistent trends more attractive, as high risk usually involves high rewards.

Trend analysis usually tries to predict trends such as a bull market run until a trend reversal, such as a bull-to-bear market. It is helpful as investors are likely to make a profit by moving with trends and not against them. Market trend analysis is based on the notion that the company’s past performance gives traders a good idea to predict future events.

The first step in analysing applicable data is to determine the market segment. Upon selecting the market sector and, in certain cases, even a particular type of investment, you can examine the sector's general performance. This may include understanding the impact of internal and external forces on the sector.
 

Types of Trend

Trend analysis is computed using numerical data which is usually historical, either in the form of traditional data, i.e the company’s performance as extracted from its public financial statements, or alternative data. You can identify three types of trends after adding the numerical data chart.

●  Upward Trend 

The trend implies an increasing number of data points. Based on the variable being examined, this can lead to several conclusions. An upward movement in the price of a stock usually indicates a favourable condition and perceives the stock to be a worthwhile investment. The upward trend is also characteristic of a bull market.

●  Downward Trend

A downward trend indicates a decreasing value of the examined variable. For instance, a sharp decline in a company's profits may require the trader and investors to be cautious of the declining price of the risky stock. This would also apply to other economic and financial variables demonstrating a downward trend.

A decrease in the price of company stock indicates the presence of a bearish market. In such scenarios, the investment is likely to result in a loss and is not advisable as its price may continue to decline.

●  Horizontal Trend 

This trend indicates a period of stagnation. It implies that the stock price or other examined metrics and variables are stagnant. In practice, a stagnant trend may go up for one period, then reverse, settling on an overall general direction. It may prove risky, to make any investment decisions based on a horizontal trend.
 

Importance of Trend Analysis

One of the core benefits of share market trend analysis is that it is a straightforward investment analysis tool. It also makes it easy to compare the performance of two or more businesses over the same period, i.e., Company A is stronger than Company B in the pharmaceutical sector as the stock price has rallied for the former versus the latter. 

Trend analysis is also utilized with a myriad of numerical data types, ranging from traditional data such as profit or expenses and alternative data such as website traffic, customer complaints, POS transactions, etc.

Long-term trends can also help identify actionable patterns, to use later for forecasts. Market trend analysis can help examine preliminary financial statements to identify any inconsistencies and ensure that any adjustments are required before the public release of the financial statements.

Trend analysis is crucial as it allows the examination of the entire stock market in an attempt to detect any signs of potential changes in the trend, whether positive or negative.
 

Trends Trading Strategies

Traders with a trading style that attempt to book profits by analyzing the momentum of an asset in a particular direction are referred to as trend traders. They usually enter into a long position when an asset or security is trending in the upward direction. This direction is characterized by higher swing lows and higher swing highs. Likewise, trend traders may opt to move for a short position if the asset displays a downward trend, characterised by lower swing lows and lower swing highs.

Trend traders try to isolate and make profits by trend analysis in the stock market. Multiple trend trading strategies make use of several technical indicators, like

●  Moving Averages: When a short-term moving average crosses above a long-term moving average, trend traders enter into a long position. They enter a short position when a short-term moving average crosses below a long-term moving average.

●  Momentum Indicators: Trend traders enter a long position when an asset is trending with strong momentum and exit a long position on a security’s loss in momentum. RSI or relative strength index is a technical indicator that measures the speed at which the recent price of security changes. The momentum indicator strategy makes use of RSI extensively.

● Trendlines and Chart Patterns: These set of strategies involve the trader taking a long position in the scenario where security is trending higher and placing a stop-loss below the key trendline support levels. If the stock starts to reverse, the trader exits the position to book a profit.

Technical indicators can simplify price information, provide trend trade signals and warn of reversals. They can be used on all time frames and have adjustable variables to match the specific preferences of each trader.

It is usually advisable for traders to combine indicator strategies or set up personal guidelines to establish entry and exit criteria for trades.
 

Conclusion

Trend analysis is a valuable tool for investors, traders, and business owners. The value of trend analysis can not be separated from data-driven decisions, basis the availability of data, especially when leveraging alternative data.

Alternative data also referred to as external data, are data points collected from non-traditional, external data sources which are generated from individuals, business processes, or sensors. Businesses and investors leverage alternative data to extract valuable insights, generate business opportunities, improve sourcing of deals and guide decisions determining investments.

Share market trend analysis driven by data is considered an excellent approach for anticipating future events, enhancing investment guiding decisions, and identifying better opportunities in business.

According to the efficient market hypothesis (EMH), stocks always trade at their fair value, and therefore investors can’t purchase any stocks that may be undervalued or sell stocks at inflated prices. This implies that the past does not predict the future and history does not necessarily need to repeat itself.
 

Read more about : Trends in Technical Analysis

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