Trend Analysis - Explained
What is a Trend Analysis?
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Table of ContentsWhat is a Trend Analysis?How is a Trend Analysis Used?Types of Trends AnalysisTypes of Strategies in Trend AnalysisShortcomings of the Trend AnalysisAcademic Research on Trend Analysis
What is a Trend Analysis?
Trend analysis is a statistical technique used in technical analysis with the aim of determining future market movements with historical data. This tool is used with the assumption that history always repeats itself, and that the exact time of this repetition can be predicted. Trends are of three different types; short trends, long-term trends and scalp or swing trends (Trends used in analysing future patterns for more than a month but less than three months).
- Trend lines aims to predict (although most traders would say the word predict is over used) market movement like bull market runs (a period filled with high-buying activities), and made use of that pattern, till a reversal (resistance levels) to a bear run (period of high-selling activities).
- The motto for this tool is that history repeats itself
- This tool is mainly focused on short, scalp, and long-term trading.
How is a Trend Analysis Used?
Trend analysis aims to predict market movements, like a bear run (more selling than buying), and uses this trend for trading till a reversal occurs. Reversals mostly occur at a resistance (the highest point which a trend can reach before bouncing back) or a support (lowest point where a trend can reach before bouncing off). Trend analysis holds great profit potentials for the wise investor when properly implemented. The movement of the market within a specific period of time is called a trend. Trends can differ depending on the type of market at that period. Markets are separated into bullish and bearish market, two terms for defining high buying and selling periods respectively. Trend analysis works better when a given trend has occurred for a long amount of time. The longer a trend occurs, the stronger it becomes, and the more chance it has of staying that way. Trend analysis is the act of using past and present market trends to predict future movement patterns. It is considered a part of comparative analysis, where two details from a market are compared to bring out a future result. Experienced statisticians are able to use this tool to determine if a market will continue in its current pattern, or reverse to the opposite pattern. It is also helpful in comparing stocks in two markets like the London Stock Exchange (LSE), and the New York Stocks Exchange (NYSE). It is important to note that no matter how good a system can be, it is highly incapable of providing perfect future predictions at all times. Thus, investors should understand that this system is also accompanied with risks.
Types of Trends Analysis
The most important step in trend analysis is knowing which market sector to follow. These sectors can either be the technology industry, or markets such as the stocks and Forex markets. You can easily evaluate the performance of the selected industry using historical data. These data also gives you information on the forces that affect trends in the industry. Examples of this forces could be changes in the unemployment rate of a nation. When all the steps of information gathering has been concluded, then statisticians can use these data to predict the next possible market movement. Trend Following This is the process of using trend analysis to make trades in the market. When an investors creates a a portfolio based on the history or results gotten from analysing the trend of that portfolio, he or she is said to be following the trend.
Types of Strategies in Trend Analysis
Analysts, as well as traders, are only aiming for profits when making use of trend analysis in a market. Indicators are very important parts of trend trading, as they help to determine the next pattern of a market. Examples of these indicators include:
- Moving Averages (MACD): This indicator suggests buying (also known as long in the market) when sell MACD crosses over a buy MACD. On the other hand, it involves selling (also known as short) when a sell MACD crosses under a buy MACD.
- Momentum Indicators: The Relative Strength Index (RSI) is the ideology of momentum indicators. Traders are advised to create new trades depending on the nature of the momentum (i.e., strong or weak momentum).
- Trend Lines and Charting Patterns: This strategy involves placing trades when a security is trending in either direction and placing a stop-loss (an automatic order to the broker which allows him to remove you from a trade if youre losing more than you can afford) or a take-profit below and above a support line and a resistance line respectively.
Shortcomings of the Trend Analysis
Like every other market strategy, trend analysis has a lot of shortcomings as movement patterns are irrational (they do not follow any set of rules). Most traders especially those who hate the idea of technical analysis trading believe that trend lines do not necessarily provide good-enough information about future trends as history doesnt always repeat itself. Market movements can be likened to the wind, as they do not follow a particular pattern and can change directions at any given time.
Academic Research on Trend Analysis
- Next generation software for functional trend analysis, Berriz, G. F., Beaver, J. E., Cenik, C., Tasan, M., & Roth, F. P. (2009). Next generation software for functional trend analysis. Bioinformatics, 25(22), 3043-3044.