When it comes to investing in stocks, it is vital for investors to understand how the market functions. Now, one of the key things to learn to understand this is trend analysis.
But before we begin, let’s understand the concept of trends in the stock market.
Trend refers to the direction in which the price of a stock is moving. Share prices usually move upwards or downwards based on bullish or bearish market sentiments. Usually, they do not move in a straight line as stock prices can be subject to high volatility in the short term. Investors need to consider a specific timeframe to consider the stock price movements as a trend.
When individuals consider somewhat long-term price movements, they can identify a much more defined market trend. In other words, the longer a trend moves in an upward/downward direction, the easier it becomes to identify it.
Market trend analysis is a process that allows investors to estimate the future price movements of stocks by analysing the ongoing market trend. Thus, through this method, investors can try to predict whether a sector that’s expanding would continue to grow or not. Trend analysis involves analysing extensive data. However, note that there is no guarantee in relation to the accuracy of the predictions.
Once investors understand what trend analysis is, it is imperative that they explore some of the various strategies involved.
Here are a few trend analysis methods that investors must be familiar with:
In the world of finance, moving average or MA refers to a stock indicator that traders use when undertaking technical analysis. The main purpose of computing moving averages is to reduce the impact of short-term price fluctuations of a stock over a specific period of time.
Traders who opt for this strategy enter long positions when a short-term MA moves above a long-term MA. On the other hand, when the short-term MA moves below the long-term MA, traders who choose this strategy enter short positions.
Let’s take the example of Tata Motors Ltd.
From the above image, we can observe that traders can choose to enter a long position when the short-term MA moves over the long-term MA.
One may utilise this tool to determine the weakness and strength of a stock’s price. Momentum gauges the rate at which the price of a stock increases or decreases. Some common examples of momentum indicators are moving average convergence divergence (MACD) and relative strength index (RSI).
This strategy involves entering a long position when the price of a stock is moving upwards or downwards with a lot of momentum. That said, investors following this strategy square off their long position when the shares of the company lose momentum. In most cases, individuals use the relative strength index (RSI) when implementing this strategy.
From the stock price chart of Tata Motors Ltd given above, one can observe that the shares of the company trend higher as momentum increases.
Trendlines refer to a sequence of lines and curves that are used in technical analysis to identify price patterns. Traders can use this tool to spot support and resistance on a stock price chart.
Individuals who choose this stock market trend analysis strategy enter long positions when the equity shares of any company are trending higher. Moreover, this method involves placing a stop-loss order below the resistance or support levels, i.e. the key trendline.
Let’s take the example of Tata Motors Ltd. once again.
Here we can observe the time when shares of this automobile manufacturer are trending higher. In this case, Traders can place a stop-loss order at or below the support area.
These market trend analysis strategies assist traders in simplifying stock price information. Moreover, they provide technical analysts with reversal signals as well as trade signals. Individuals may choose to combine these trend analysis strategies and then adjust them according to their own preferences.
Experts believe that traders should combine the various trend analysis methods and formulate their own strategies. This would enable individuals to clearly identify the entry and exit points.