Trend Analysis – The Use Of Trend

By Vikram 26 Comments 28 Sept 2018

A Formal Definition

Trends aren’t always easy to spot because prices almost never move in straight lines. Rather, prices tend to move in a series of highs and lows over time. In technical analysis, it is the overall direction of these highs and lows that constitute a trend. An uptrend is classified as a series of higher highs and higher lows, while a downtrend consists of lower lows and lower highs.


Trend Analysis

This is an example of an uptrend. Each of the high points of the trend – 2, 4, and 6 – are higher than the previous high, while each of the low points of the trend – 3 and 5 – are higher than the previous low. For the uptrend to continue, the next low point must be above 5 and the next high point must be above 6, else the trend will be deemed a reversal.






Types of Trends

There are three types of trends :–

  • Uptrend
  • Downtrend
  • Sideways / Horizontal Trends

Sideways or horizontal trends occur when there is little movement up or down in the peaks and troughs of a trend. If you want to get technical, you might even say that a sideways trend is actually the absence of any well-defined trend in either direction.

Trend Lengths

In addition to their direction, trends can be classified in terms of their length. Most traders consider trends short-term, intermediate-term, or long-term. Long-term trends occur over a timeframe of longer than one year; intermediate-term trends occur over one to three months; and, short-term trends occur over less than one month.

Here’s an example of how these trend lengths look in practice –


Trend Lengths

Trend Lengths

Using Trend Analysis

A trend analysis is an aspect of technical analysis that tries to predict the future movement of a stock based on past 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 is the process of trying to look 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 an analysis may involve a large amount of data, there is no guarantee that the results will be correct.

In order to begin analyzing applicable data, it is necessary to first determine which market segment will be analyzed. An example of sectors can include a 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 the general performance of the sector. 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 analysis involves the collection of information from multiple time periods and plotting the information on a horizontal line for further review. The intent of this analysis is to spot actionable patterns in the presented information. In business, trend analysis is typically used in two ways, which are as follows:-

Revenue and Cost Analysis :–

Revenue and cost information from a company’s income statement can be arranged on a trend line for multiple reporting periods and examined for trends and inconsistencies. For example, a sudden spike in expense in one period followed by a sharp decline in the next period can indicate that an expense was booked twice in the first month. Thus, trend analysis is quite useful for examining preliminary financial statements for inaccuracies, to see if adjustments should be made before the statements are released for general use.

Investment Analysis :–

An investor can create a trend line of historical share prices, and use this information to predict future changes in the price of a stock. The trend line can be associated with other information for which a cause-and-effect relationship may exist, to see if the causal relationship can be used as a predictor of future stock prices. Trend analysis can also be used for the entire stock market, to detect signs of a impending change from a bull to a bear market, or the reverse.


When used internally (the revenue and cost analysis function), trend analysis is one of the most useful management tools available. The following are examples of this type of usage:

  • Examine revenue patterns to see if sales are declining for certain products,
  • customers, or sales regions.
  • Examine expense report claims for evidence of fraudulent claims.
  • Examine expense line items to see if there are any unusual expenditures in a reporting period that require additional investigation.
  • Extend revenue and expense line items into the future for budgeting purposes, to estimate future results.

When used internally (the revenue and cost analysis function), trend analysis is one of the most useful management tools available. The following are examples of this type of usage:

  • Examine revenue patterns to see if sales are declining for certain products, customers, or sales regions.
  • Examine expense report claims for evidence of fraudulent claims.
  • Examine expense line items to see if there are any unusual expenditures in a reporting period that require additional investigation.
  • Extend revenue and expense line items into the future for budgeting purposes, to estimate future results.

When trend analysis is being used to predict the future, keep in mind that the factors formerly impacting a data point may no longer be doing so to the same extent. This means that an extrapolation of a historical time series will not necessarily yield a valid prediction of the future. Thus, a considerable amount of additional research should accompany trend analysis when using it to make predictions.


Support & Resistance

An Introduction

Support and resistance are the next major concept after understanding the concept of a trend. You’ll often hear technical analysts talk about the ongoing battle between bulls and bears, or the struggle between buyers (demand) and sellers (supply). The proverbial ‘battle lines’ can be defined as the support and resistance levels where the most trading occurs. Support levels are where demand is perceived to be strong enough to prevent the price from falling further, while resistance levels are prices where selling is thought to be strong enough to prevent prices from rising higher.

Channels

A channel consists of two trendlines that act as strong areas of support and resistance with the price bouncing around between them. The upper trendline consists of a series of highs, while the lower trendline consists of a series of lows. A channel can slope upward, downward, or sideways, but regardless of the direction, the interpretation is always the same. Traders expect the price to trade between the support and resistance trendlines until it breaks out beyond one of the two levels, in which case traders can expect a sharp move in the direction of the breakout. Along with clearly displaying the trend, channels are used to illustrate important areas of support and resistance for the stock price.

Channels

As you can see in the above chart, the price channel from the previous section, the bottom trendline represents a key support level while the upper trendline represents a key resistance level. The arrows near the top and bottom trendlines show the levels where the price seldom surpassed until it broke out higher. After the breakout, the upper trendline transitioned from a resistance level to a support level for the new trend.

Why Does This Happen?

Support and resistance levels are psychologically-important levels where a lot of buyers and/or sellers are willing to trade the stock. When the trendlines are broken, the market psychology shifts and new levels of support and resistance are established.

Importance of Support and Resistance

Support and resistance levels are a critical part of trend analysis because it can be used to make specific trading decisions and identify when a trend is about to reverse. For example, a trader might identify an upcoming support level and decide to start buying the stock as it approaches knowing that it will likely rebound higher. These levels both test and confirm trends and should be closely monitored by anyone using technical analysis. As long as the price remains between these two levels, the trend is likely to continue in the prevailing direction.

However, a break beyond support or resistance does not always indicate a reversal. For example, a breakout higher may be the start of a faster bullish trend and vice versa for a breakdown below trendline support. There are also instance of ‘false breakouts’ when a price may breakout higher on low volume and then fall back into a price channel.

Traders should be aware of support and resistance levels and avoid placing orders at these major points since they’re usually characterized by a lot of volatility. If you feel confident about making a trade near these levels, it’s important to avoid placing orders directly at the level since they are rarely reached. This is because the price never actually reaches the whole number, but rather, flirts with the levels before rebounding. Traders may also place stops or short selling orders around these levels to capitalize on a breakdown or breakout.

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