What Is Trend Analysis?
Trend analysis is a technique used in technical analysis that attempts to predict future stock price movements based on recently observed trend data. Trend analysis is based on the idea that what has happened in the past gives traders an idea of what will happen in the future. There are three main types of trends: short-, intermediate- and long-term.
- Trend analysis tries to predict a trend, such as a bull market run, and then ride that trend until data suggests a trend reversal, such as a bull-to-bear market.
- Trend analysis is based on the idea that what has happened in the past gives traders an idea of what will happen in the future.
- Trend analysis focuses on three typical time horizons: short-; intermediate-; and long-term.
How Trend Analysis Works
Trend analysis tries to predict a trend, such as a bull market run, and ride that trend until data suggests a trend reversal, such as a bull-to-bear market. Trend analysis is helpful because moving with trends, and not against them, will lead to profit for an investor.
A trend is the general direction the market is taking during a specified period of time. Trends can be both upward and downward, relating to bullish and bearish markets, respectively. While there is no specified minimum amount of time required for a direction to be considered a trend, the longer the direction is maintained, the more notable the trend.
Trend analysis is the process of looking at current trends in order to predict future ones and is considered a form of comparative analysis. This can include attempting to determine whether a current market trend, such as gains in a particular market sector, is likely to continue, as well as whether a trend in one market area could result in a trend in another. Though a trend analysis may involve a large amount of data, there is no guarantee that the results will be correct.
Examples of Trend Analysis
In order to begin analyzing applicable data, it is necessary to first determine which market segment will be analyzed. For instance, you could focus on a particular industry, such as the automotive or pharmaceuticals sector, as well as a particular type of investment, such as the bond market.
Once the sector has been selected, it is possible to examine its general performance. This can include how the sector was affected by internal and external forces. For example, changes in a similar industry or the creation of a new governmental regulation would qualify as forces impacting the market. Analysts then take this data and attempt to predict the direction the market will take moving forward.
Trend Trading Strategies
- Moving Averages: These strategies involve entering into long positions when a short-term moving average crosses above a long-term moving average, and entering short positions when a short-term moving average crosses below a long-term moving average.
- Momentum Indicators: These strategies involve entering into long positions when a security is trending with strong momentum and exiting long positions when a security loses momentum. Often, the relative strength index (RSI) is used in these strategies.
- Trendlines & Chart Patterns: These strategies involve entering long positions when a security is trending higher and placing a stop-loss below key trendline support levels. If the stock starts to reverse, the position is exited for a profit.
Indicators can simplify price information, as well as provide trend trade signals or warn of reversals. They may be used on all time frames, and have variables that can be adjusted to suit each trader's specific preferences.
Usually, it is advisable to combine indicator strategies or come up with your own guidelines, so entry and exit criteria are clearly established for trades. Each indicator can be used in more ways than outlined. If you like an indicator, research it further, and most importantly, test it out before using it to make live trades.
Trend following is a trading system based on using trend analysis and following the recommendation produced to determine which investments to make. Often, the analysis is conducted via computer analysis and modeling of relevant data and is tied to market momentum.
Limitations of Trend Analysis
Critics of trend analysis, and technical trading in general, argue that markets are efficient, and already price in all available information. That means that history does not necessarily need to repeat itself, and that the past does not predict the future.
Adherents of fundamental analysis, for example, analyze the financial condition of companies using financial statements and economic models to predict future prices. For these types of investors, day-to-day stock movements follow a random walk that cannot be interpreted as patterns or trends.