What Is Trend Analysis?

Trend Analysis Explained

Definition
Trend analysis is a type of technical analysis that helps investors identify the current price trends of a security. It is often used as an indicator to assist investors in placing a buy or sell transaction.
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Trend analysis is a type of technical analysis that helps investors identify the current price trends of a security. It is often used as an indicator to assist investors in placing a buy or sell transaction. Based on the underlying indicators, price movements can be in an uptrend, downtrend, or sideways trend.

Definition and Example of Trend Analysis

Trend analysis is the analysis of trends in price movements of a security— it’s an essential piece of technical analysis. Trends are made up of peaks and troughs of a stock chart that you can analyze and determine market trends accordingly. 

A day trader might use trend analysis to determine whether to invest in a particular security and the right timing to invest in that security. For example, Latasha bought shares of ABC Construction a few months ago. She wants to sell but isn’t sure if it’s the right time. To figure out when the right time is, she analyzes the trend of ABC Construction and identifies a resistance level of $95 per share, which indicates that she should sell when the price hits $95.

How Does Trend Analysis Work?

When investors and traders analyze trends of the price of a security, they generally do so following short-term, intermediate, and long-term time frames. For individual investors, a good rule of thumb for trend timeframes is: 

  • Short-term: Less than one month
  • Intermediate: One to three months
  • Long-term: One year or longer

Institutional investors may stretch those timelines to three to six months, six months to two years, and more than two years (long-term). As for the trends themselves, they’re typically classified into up, down, and sideways. Up indicates growth over time, down indicates a price drop over time, and sideways indicates a price that has stayed relatively the same.

Note

Day traders may analyze trends in time frames as short as just 1-minute windows.

Let’s say Shonda has been watching the price movements of XYZ Software’s stock. Through trend analysis and price charting tools, she notices that over the four months, the stock price of XYZ Software has consistently reached a new 52-week high followed by about a 1% decline. This has happened at least bi-weekly over the past four months. This may indicate to Shonda that the stock is on an “upward” trend and that, once it reaches a new 52-week high and then drops 1%, she may have a window of opportunity to invest in that company as it trends towards a new price high.

Types of Trend Analysis

There are many different price and chart indicators used to determine the trend of a stock price. Some of the most common types of indicators used include:

Moving Averages

A simple moving average line equals the sum of all the prices of a stock over a given time, divided by that time frame. Some standard moving average time frames are 20, 50, and 200 days.

Trading Volume

Investors will use trading volume to indicate how much activity is happening behind a price trend. Trading volume measures how many shares are traded during a defined period, and some investors look for relationships between trading volume and share price to make their investing decisions.

Support/Resistance Lines

A support line represents a stock price low maintained over a defined time frame, while a resistance line represents a stock price high maintained over a defined time frame. These lines are often used as buying or selling indicators—buyers purchase the stock at a certain low price point over time (support), and sellers sell the stock at a certain high price point over time (resistance).

Chart/Price Patterns

Traders will look for multiple indicators of the direction of a stock price that generally fall within two categories: continuation chart patterns and reversal patterns. Continuation chart patterns indicate that the price will continue its current trend, and reversal patterns indicate that the price will change its trend direction. Typical example chart patterns include head-and-shoulders, triangle, rectangle, wedge, and double-top.

These are just a few of the common indicators among many that are used to identify price trends of a security. Other price indicators to predict a trend include:

  • Price oscillators
  • Directional movement index
  • Exponential moving averages
  • Moving average convergence-divergence (MACD)
  • Volume-adjusted moving average
  • Weight-adjusted moving average (WMA)
  • Keltner bands
  • Linear regressions

Note

Trend analysis isn’t a perfect science—the past performance of a stock is not a guarantee of future performance. Additionally, never rely on a single trend-analysis method to make your investing decisions.

What It Means for Individual Investors

While most technical analysis strategies, like trend analysis, are used by short-term day traders and swing traders, long-term investors can use trend analysis to maximize their profit on entry and exit transactions. So whether you’re a long-term investor, work as a day trader for an institution, or you’re a swing trader, understanding how to predict price trends can make a big difference in your overall profit when followed consistently and logically. 

Key Takeaways

  • Trend analysis is a type of technical analysis investors follow to determine the future price movements of a security.
  • Trends are made up of peaks and troughs over time, allowing one to predict the overall price movement of a security.
  • There are typically three time frames used when analyzing stock price trends. They are short-term (less than one month), intermediate (one to three months), and long-term (one year or more).
  • The most common indicators for trend analysis include moving averages, trading volume, support and resistance lines, and common chart patterns like triangles and double-tops.
  • Trend analysis does not guarantee the future price movement of a stock and should be used in addition to other indicators.
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Sources
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  1. Fidelty. "Basic Concepts of a Trend." Accessed Feb. 15, 2022.

  2. Fidelity. "What Is Trend Analysis?" Accessed Feb. 15, 2022.

  3. Asia-Pacific Journal of Financial Studies. "The Impact of Day-Trading on Volatility and Liquidity," Page 245. Accessed Feb. 15, 2022.

  4. Charles Schwab. "Filtering the Market Using Technical Analysis." Accessed Feb. 15, 2022.

  5. Fidelity. "Technical Indicator Guide." Accessed Feb. 15, 2022.

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