An introduction to stock market trend analysis

By Riya Jain & Priya Chetty on July 31, 2020

In the context of the stock market, the trend simply refers to the graphical representation of the stock market’s direction of movement. Depending on a bearish or bullish trend, the stock market either moves downwards or upwards. Stock market trend analysis or equity market trend analysis refers to the process of examining the current trends based on the past and current movement of the stocks in order to predict future trends (Motilal Oswal, 2019).

Stock market trend movements
Figure 1: Stock market trend movements

Understanding the concept of stock market trend analysis

Stock market trend analysis is a technical form of stock market analysis wherein the future movement of stocks can be determined based on recently observed data (Hayes, 2019).

NOTE

If a company shows an upward trend for 48 consecutive months in the rate of return, chances are that the trend will continue in the near future too.

Trend analysis of large amounts of data adds makes the prediction of the future trend more reliable but does not guarantee the result. The movement in data does not show a straight line, instead, there is a presence of fluctuations. The direction of the movement indicates whether the market is gaining or losing. Irrespective of the direction of trend movement, stock trends can be divided into three categories: short-term, intermediate-term, and long-term (Hayes, 2019; Radukić & Radović, 2014).

Types of stock trends
Figure 2: Types of stock trends

There is no minimum requirement for the size of the data or time period. However, in general, the longer the trend, the more reliable the movement for prediction.

Different strategies that can be used for trend-based analysis

Stock market trend analysis could be undertaken by using three different strategies.

Moving average

A moving average-based trend analysis refers to the study of the current direction of the stocks by averaging the variable over a specified period of time.

EXAMPLE

A 2-day moving average-based analysis of a 1-month return would be based on graphically representing the average value of a 2-day return for each day.

Devcic, 2019

Momentum indicators

These are the tools that help in tracking the price movement of securities. Although the direction of the movement cannot be determined by the momentum indicators, the movement of the prices or their strength can be examined. Some of the most popular momentum indicators are the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), and Average Directional Index (ADI). These indicators do not give much information about the direction of the trend, therefore it works better with moving average or other price trends (Corporate Finance Institute, 2020).

Chart patterns & trendlines

Trendline refers to the line drawn between different prices in order to determine the direction of movement. Instead of focusing on examining past performance, trendlines base the graphical representation of the prices on the current direction of movement. Trend analysis herein is done for studying the direction and speed through interval-based analysis of movement like minutely, hourly, daily, or weekly.

EXAMPLE

On the first day, the price was Rs. 10, the second-day price increased to Rs. 13, and the third-day price is Rs. 17. Thus, these three intervals show an upward movement.

Importance of stock market trend analysis

Stock market trend analysis helps in examining the changes in the stock market by considering both internal and external factors. By graphically studying the movement of the stock market, an investor can decide the optimal time for entering or exiting the stock market or modifying their portfolio. Although past performance analysis does not confirm that the same trend would be followed in the future, potential problems associated with the stocks can be identified by careful trend analysis (Motilal Oswal, 2019; Sykes, 2019).

References

NOTES

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