The term market trend analysis is used by many financial professionals but can have a different meaning, depending on who you talk to. At its most basic level, trend analysis is defined as the collection of historical data for the purposes of making future predictions or forecasts. It is believed that when certain conditions continue to present themselves with a similar outcome, there is a higher probability for these conditions to yield the same outcome in the future.
At the highest level, many pundits will pontificate on the future prospects for the economy through economic trend analysis. Inflation, employment data, housing, consumer spending, consumer confidence, and interest rates are just some of the key indicators that they will track closely. For example, it is historically observed that an inverted yield curve (short term interest rates higher than long term interest rates) typically precedes a period of economic recession. Similarly, inflation trend analysis will show that the economy goes through cycles of increasing inflation followed by decreasing inflation. During high periods of inflation, traders tend to move assets into inflation hedges such as gold and oil. It is important to understand the implications of economic trend analysis as it can help you understand where to keep your assets.
Economic trend analysis is the first part of your investment picture; it provides the backdrop for the type of economic environment you will be investing in. When you understand where to invest your assets, a more sector specific or company specific analysis should be performed. Stock trend analysis and financial trend analysis are the two main forms of investment analysis that can be performed.
Stock trend analysis, or technical analysis, is the art of studying previous price patterns and making forward looking assumptions on where price will head. Technical analysis has become increasingly popular among the day trading and swing trading crowd with the vast availability of historical data. Traders can slice and dice this data in any way they please, uncovering repeatable patterns and back testing trading strategies without putting real money to work. This is truly a study of human emotion and money flow versus a study of a company’s balance sheet.
Conversely, financial trend analysis is the art of analyzing a company’s financial performance trends. Financial performance can be gauged against prior periods or even against industry peers. This form of financial trend analysis allows investors to understand if a company is relatively improving or not, year over year. Additionally, this analysis allows companies to strategically plan and budget future initiatives and put pre-emptive measures in place to tackle emerging financial issues before they occur. Some of the most common analysis metrics are EPS, P/E ratio, A/R turnover, operating margins, and cost of capital to name a few.
Remember, past performance is no guarantee for future results. Each situation should be taken on a case by case basis as it presents its own set of unique circumstances. The biggest mistake you can make is to throw all your chips at an investment which you believe will go up because history says it “should”.