It is not possible to invest or trade without understanding how a stock market functions. To invest wisely in stocks, it is essential to learn how to do trend analysis effectively. This will help you make smarter decisions and reap benefits from the market.
What is a Market Trend?
A market trend is a general direction in which a stock moves. The prices of shares move upwards when the market is bullish and downwards in a bearish market. These prices do not move in a straight line as they are prone to high volatility in the short term.
There is a specific time frame for a movement to be considered a trend. However, the longer the trend moves in an upward or downward direction, the more noticeable a trend becomes.
What is a Trend Analysis?
Trend Analysis is a process of analyzing current trends to predict future trends. It will help you predict whether a market sector that is growing currently, will continue to grow in the future. Or, whether a trend in one sector will give rise to another trend in the market. The entire process requires a lot of analysis and data. However, it is important to note that it’s not possible to predict a trend with a full guarantee.
Trend Analysis is a part of technical analysis that helps in predicting the future movement of a stock based on previous data. It wouldn’t be wrong to say that the past trend can serve as a window to future trends. The share market trends are of 3 types – short-term, intermediate-term, and long-term.
3 Strategies for Effective Trend Analysis
Once you understand what trend analysis is, the next step is to learn and apply the 3 important strategies for effective trend analysis. Following are the 3 methods of analyzing a trend in the stock market:
- Momentum Indicator
This strategy can be used to determine the strength and weakness of the price of a stock. Momentum measures the rate at which the price of a stock decreases or increases. MACD (Moving Average Convergence Divergence) and RSI (Relative Strength Index) are examples of momentum indicators.
This indicator involves entering a long momentum when the stock’s price is moving up and down with a lot of momentum. Investors who follow this strategy square off their long position when the shares lose momentum. Usually, the investors use RSI or Relative Strength Index while implementing this method.
- Moving Average
In the Finance domain, MA or Moving Average is known as a stock indicator that is used by the traders while carrying out technical analysis. The main aim of calculating Moving Average is to reduce the effect of short-term price fluctuations of a stock over a specific time- period.
Traders who use this method enter long positions when a short-term Moving Average moves above a long-term Moving Average. On the contrary, when the short-term Moving Average moves below the long-term Moving Average, the traders who opt for this strategy enter short positions.
- Trendlines and Chart Patterns
Trendlines are the sequence of curves and lines that are used in the technical analysis for identifying the price patterns. This tool can be used by the traders to spot the resistance and support on a price chart.
Individuals who opt for this strategy enter a long position when the shares of a company trend higher. Also, this method involves putting a stop-loss order below the support or resistance levels (the key trendline).
These strategies help simplify the stock market data. Furthermore, they provide trade signals and reversal signals to technical analysts.
Stock Market Experts suggest that you should combine the different methods of trend analysis and formulate your strategy for effective results. This will help you identify the entry and exit levels.
Frequently Asked Questions
- What are the 5 rules for an accurate stock market trend analysis?
Following are the 5 rules you can use to carry out an accurate stock market trend analysis:
- Three Data Points Needed – Only when you have 3 or more points of contact, a trend is considered valid.
- Direction – Stock market trends can move in 3 directions – up, down, and sideways. If you study the prices over a long duration, you can check out all three types of trends in the same chart.
- Time the Trend – Time determines the validity of a trend. Usually, monthly time series carry more importance than weekly prices, which supersede daily prices.
- Watch the Slope – The slope of a trend indicates how much the price should move each day. Steep lines (up or down) indicate a certain trend. But, if the line is too flat, it questions both the validity of the trend and its predictive powers.
- Long-Lasting – The longer a trend remains, the greater the weight it carries.
- How do you know that a stock market trend is valid?
A stock market trend is valid if many indicators point in the same direction. It will be valid until it starts showing the signs of reversal. Some stocks show clear signs of a change in trend.
- What are the advantages of trend analysis in the stock market?
The Advantages of stock market trend analysis are:
- Less Prone to Mistakes – Trend analysis is fully based on the study of chart patterns. This limits your input and makes the analysis less prone to misinterpretations.
- Full Analysis – In trend analysis, all the conclusions are drawn from the historical trends. All the data is present on the screen right in front of you. You need to read the charts to understand the market trends.
- Assumption Free – There is no room for assumptions in trend analysis. You need to read the data available to you in the form of charts and draw a conclusion.
- What are the disadvantages of stock market trend analysis?
Following are the disadvantages of stock market trend analysis:
- History Doesn’t Repeat Itself
You cannot predict the future based on past events. The technology is improving and the businesses are redefining themselves. So how can you continue with an approach that ignores this and works only with past data?
- Only Useful For Old Stocks
The main criterion of trend analysis is that a stock should have a long trading history. Only then you will be able to analyze old patterns and make an opinion about the future. This makes trend analysis ineffective in the evaluation of new development.
For example, in the 1990s, the US saw a boom in the technology sector. The stock market reached a new high due to new IT companies. These companies did not have a long trading history. Therefore, the technical experts could not apply their skills and were unable to benefit from one of the biggest booms in the world.
- Why is share market analysis important for a trader or investor?
There is a lot of information or data involved in share market trend analysis. To start analyzing, you need to first identify which sector you want to pick. Your focus can be on the bond market or the automobile sector. Once you select the sector, you can start with a detailed analysis.
The trend analysis of the stock market includes both internal and external factors that affect it. A new government or changes in the industry serve as forces that impact the market. The data is then analyzed to predict the direction of the market moving forward.
It is important to understand the sense behind the trading trend in the stock market. You know that you would not drive your car on the wrong side of a one-way street. Similarly, you should never trade against the trend in a stock market.