What is Trend Analysis?

17 Mar 2022  Read 1742 Views

The stock market is a crazy place! And we never know what its next move will be. In April 2020, the markets came down to the level of 8000 and in one year, in April 2021 was trading at all-time highs. Yes, I know, a crazy place. Investors & traders worldwide work day & night to understand the stock market. There are various theories and analysis tools that try to explain its workings and movements, and one such tool is Trend Analysis. 

So what is it? Let’s find out today!

Understanding Trend Analysis? 

In simple terms, it is a method of technical analysis that helps the traders or investors to predict the future movements in the market or some specific stocks based on the current direction of past and ongoing trends in the stock market.

This analysis helps in understanding the future happenings based on past occurrences. 

Trend analysis forecasts the long-term direction of the market sentiment using past data such as price movements and transaction volume.

The objective of Trend analysis is to forecast a trend, such as a bull market rally, and then go along with that trend until data indicates a trend reversal, such as a bull-to-bear market.

It is beneficial because investors will profit if they move with the trends rather than against them.

Let’s first understand what the trend is. A trend is a general direction in which the market moves over a given period. Trends can be both upward and downward, corresponding to bullish and bearish markets. While there is no set length of time for a direction to be deemed a trend, the longer it is maintained, the more noticeable the trend becomes.

This can include determining if a current market trend, such as increases in a specific market sector, is likely to continue, as well as whether a trend in one market area may lead to a trend in another. Despite the fact that a trend analysis may entail a vast quantity of data, the accuracy of the conclusions cannot be guaranteed.

One point to keep in mind is that the longer the trend, the more reliable it is.

Traders can also analyse if a trend in one sector could result in the same trend in another sector.

Types of Trends

Talking about its types: Based on the time period, there are three types of trend analysis which consist of short-term, long-term, and intermediate trends. 

Based on the pattern, three types of trends are:

Uptrend

An uptrend or bull market occurs when financial markets and assets, as well as the larger economy, move in the same direction and continue to raise stock prices, asset values, and even the size of the economy over time. It is a period of booming when jobs are being generated, the economy is moving into a good market, the market mood is positive, and the investment cycle has begun.

Downtrend

A downturn or bear market occurs when financial markets and asset prices – and the size of the economy as a whole – go in the wrong direction and stock or asset values, or even the size of the economy, continue to fall over time. It's the time of year when businesses close down or reduce production owing to a drop in sales. Job losses occur, and asset prices begin to fall; market sentiment is not favourable for further investment, and investors seek refuge in the investment haven.

Sideways/Horizontal Trend

A sideways/horizontal trend occurs when asset prices or share prices do not move in either direction; instead, they move sideways, up for a period of time, then down for a period of time. It is impossible to predict the trend's direction. It's a trend in which investors are concerned about their investments, and the government is attempting to boost the economy. In general, a sideways or horizontal trend is regarded as risky since it is impossible to forecast when sentiment would shift against it; as a result, investors try to stay away from such a circumstance.

How does trend analysis work

A trader may be able to match purchases and sales of specific stocks by keeping an eye on market developments, enhancing their profit potential. At the same time, it's critical to consider historical data in the context of the underlying company's current conditions to see if there are any elements that could alter a stock's value despite broad market conditions or past performance. A trader, for example, should examine the company's financial situation, comprehend the market and technology, and forecast competitive pressures on the company within its industry. 

A trader benefits from all of these tools, as well as trend analysis.

Before you can begin evaluating relevant data, you must first decide which market sector will be examined. You may, for example, concentrate on a specific industry, such as the automobile or pharmaceuticals industries, or a specific sort of investment, such as the bond market.

After you've decided on a sector, you may look at its overall performance. This can include how internal and external factors influence the sector. Changes in a similar industry, for example, or the enactment of new legislation etc., would be considered market forces. 

Analysts then use this information to try to predict where the market will go in the future.

Trend analysis is a type of comparative analysis that involves looking at present trends in order to anticipate future ones. This can include determining if a current market trend, such as increases in a specific market sector, is likely to continue, as well as whether a trend in one market area may lead to a trend in another. 

Trend trading strategies 

Traders can combine indicator strategies, or they can come up with their own strategies, so entry and exit criteria can be clearly established for trades.             

Let’s discuss in detail some of the trend trading strategies: 

  • Moving Averages: 

 When a short-term moving average crosses above a long-term moving average, traders can buy long positions and vice versa. Indicators help simplify attaining price information and also provide with trend trade signals or reversal signals. 

These indicators can be adjusted according to the trader’s specific preferences. Traders can also come up with their own strategies, so entry and exit criteria can be clearly established for trades.

  • Trendlines and Chart Patterns:

 When a stock is going higher, traders can open long positions with a stop-loss below the important trendline, such as support or resistance levels. The position is squared in the event of a trend reversal.

  • Momentum Indicators 

Long positions can be taken when a stock is heading up or down with great momentum, and long positions can be closed when the stock loses momentum. In these methods, traders can employ the relative strength index (RSI).

Indicators can be used to simplify price data, provide trend trading indications, and warn of reversals. They can be utilised in any time frame and include variables that can be changed to suit the preferences of each trader.

Why not use trend analysis?

Critics of trend analysis say that markets are efficient and that all accessible information is already priced in. That is to say, history does not have to repeat itself, and the past does not necessarily predict the future. Fundamental analysts, for example, examine a company's financial situation using financial documents and economic models to forecast future pricing. Day-to-day stock movements for these investors follow a random walk that cannot be construed as patterns or trends.

Bottom Line

A well-known saying in the trader's fraternity is, "The trend is your friend". By following the trend, the trader makes a good profit, and trend analysis is not an easy process. It necessitated a keen eye for detail as well as an awareness of market dynamics. Have you ever used this trading tool? If yes, let us know in the comment box. 

Out of context! But why not 🤷‍♀️. If technical analysis intrigues you then go check out Basics of Technical Analysis only on Quest by Finology.

Quest is a 101 guide for anyone who wants to learn investing. The aim of these online finance courses is to make people financially literate and to make them understand the essential financial concepts and learn company analysis so that one can know how to create & grow their wealth in the stock market. 

About the Author: Kanishka Tayal | 26 Post(s)

Kanishka is a finance enthusiast, currently pursuing her master's in Banking and financial services domain. She loves to doodle in her spare time. She is a keen learner and is willing to pursue her career as a financial analyst.

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