Trend analysis is the process of observing and analyzing market or economic trends to make investment decisions. Trends can be analyzed over a range of time periods and predicted to determine the future price movements of a financial instrument. A trend analysis in the financial markets is a study of historical prices to assess a future price movement. Trend analysis operates on the assumption that history repeats itself and that past performance can be used to make predictions about future performance. It’s a statistical tool for analyzing many datasets in search of repeating patterns or trends which could give insight into future behaviors or events.
Trend Analysis and Technical Analysis
The simplest way to analyze the market is by simply studying its past movements. This technique is called pattern analysis or technical analysis, and can be carried out with charts, candles, bars and other charting tools. Technical analysts use mathematical and statistical analysis and apply concepts such as regression analysis, probability, and other analytical techniques to assess future stock prices. Although it is impossible to know with certainty what will happen in the future, there are ways to assess whether certain events are more or less likely given price patterns. Technical analysis is mainly performed on stocks, options, futures and currencies.
When analyzing past performance of mutual funds or other investment options, we can see which ones have been more successful based on their rates of return. This information can be used to determine which funds may perform the best in the future. This analysis is usually performed by comparing the historical performance of a set of funds or alternative investments and then analyzing them against each other with a regression analysis. This process takes into account:
A: How well an investment tracked its benchmark
B: The amount gained or lost from commissions and expenses
C: The return on invested capital (a statistic that measures the amount of risky capital returned as profit) as per performance.
D: A measure of risk (e.g., standard deviation), as measured against the benchmark figure, to determine how volatile an investment was.
Regression analysis is done with all or parts of the above listed data to determine if any relationships exist between them. The goal is to determine whether there is a statistical association, or if any statistical relationship exists at all. This tool can also be used for trend analysis, because it analyzes the relationship between two variables over time. Regression analysis helps explain how past results can be used to predict future results.
Some investors use trend-following indicators, which are technical indicators that attempt to predict prices within 2–3 days into the future. However, many current technical indicators are designed to work over a much longer time horizon. For example, a trend-following indicator might recommend buying if a security price is above a certain moving average for a few weeks in a row, but the indicator may not be able to help you make an investment decision within two days. Similarly, the indicator might recommend selling if the security price falls below a certain moving average for several weeks in a row.
Other investors use trend-following indicators but they only follow the past few weeks of trends. These indicators may change from week to week along with market conditions and other factors that affect prices of securities and may not be able to perform accurately when there are sudden or large movements in prices.
Pros and Cons of Trend Analysis
For long-term investors who are looking to invest for at least 10 years, trend analysis has the advantage of being able to provide accurate predictions. The accuracy of short-term predictions diminishes as you extend backward in time. The accuracy of short-term predictions diminishes as you extend backward in time or if market conditions change significantly. If you are interested in investing for the long term, then it may be safer to use trend analysis than other types of analysis because it can look farther into the past and because it works well with little change when market conditions change.
Another disadvantage of trend analysis is the lack of systematic rules for choosing periods over which to make predictions. Some trend indicators are based on specific time periods that may or may not be appropriate for your investment objectives. Other indicators are based on specific types of data, such as Nadex (for futures) or intermarket (for options). One advantage of using an indicator like the VIX, which is based on the volatility of the underlying market, is that this indicator works even in periods when prices change significantly.
Two other disadvantages to trend analysis are that it relies only on past price movements, which can generate inaccurate predictions if there is a sudden change in fortunes in a given security or market sector. For example, if you used trend analysis to determine that the stock market was due for a big run-up in prices, then you could rinse and repeat by using the same indicator to predict another price increase. However, if this gain were not realized, it would be hard to tell why. And lastly, trend analysis can’t be used to analyze several different securities or markets at once.
Given the advantages of Trend analysis as well as its obvious pitfalls, businesses are advised to seek expert guidance when making investment decisions whether long term or short term. Fintalent consultants offer best in class Investment managers with expert Technical Analysis, in-depth Equity Research and Portfolio Analysis that ensure our Trend Analysis and conclusions are backed up with complementing research that ensure our clients make the best investment decisions.