What is Trend Analysis?
April 26, 2021
Trend analysis refers to comparing data points over a given period, allowing you to identify increases (upward trends), decreases (downward trends), or stagnation (no change). Investors and business managers use this information to make decisions or improve strategies. A downward trend indicates that the business underperforms, while an upward trend might show an investor that the asset is worth buying. Let’s find out more about trend analysis, its benefits, and real-life examples.
Types of trend analysis
Trend analysis is computed using numerical data. This information is usually historical data, either traditional data in the form of a company’s profit taken from its public financial statements or alternative data, such as the number of job postings of a competitor in the past five years. When adding numerical data to a chart, you will be able to identify three types of trends.
An uptrend or an upward trend means that your data points are increasing. Based on what type of variable you are examining and your purpose, this could have different meanings.
For instance, you are a business owner looking at the price of raw materials required to produce bread, and you notice that the price is increasing. This information could help you make different predictions, such as increased costs for your business or the necessity of raising the prices for the final consumer.
At the same time, an investor looking at the share price of a company X who noticed an upward trend might decide to buy the stock since the price is increasing. An upward movement in a stock’s price generally indicates a favorable condition, helping you to determine if the stock is a worthwhile investment.
On the opposite side, a downward trend indicates the decreasing value of your variable. For example, if a company’s profit has a downward trend, this may require investors to proceed with caution as the stock is risky since the price is going down. This also applies when other economic or financial variables have a downward trend.
When investors research financial assets, trend analysis can be done on the asset’s historical price. If this price is decreasing, it indicates the presence of a bearish market. In other words, investment is not recommended because the prices could further decrease, leading to a loss.
Finally, the horizontal trend indicates stagnation. In other words, the prices are not going up or down; rather, they are stagnant. In practice, a flat trend might go up for a period, then going down, reaching a steady movement overall. Making investment decisions based on horizontal trends is risky because you do not know what will happen.
Key caveats of any trend analysis include recognition that prior trends do not always continue into the future. Also, short-term linear trends may actually be non-linear over longer periods, plus long-term linear trends may have short-term cycles. Finally, trend analyses are lousy at picking up black-swans or even slightly-grey-swans.
- John A. Kilpatrick, Ph.D. MAI, Greenfield Advisors
Benefits of trend analysis
Apart from being a straightforward analysis tool, trend analysis has several other benefits. Some of the main ones include:
- It is easy to compare the performance of two or more firms over the same period of time, so you can see how strong or weak a business is compared to another one in the same industry.
- Trend analysis can be used with a myriad of numerical data types, including traditional data (i.e., profit or expenses) and alternative data (website traffic, customer complaints, POS transactions, and many more).
- You can use these long-term trends to identify patterns. These patterns can afterward be used to make forecasts.
The core benefit of the trend analysis is that you can compare your incoming data with another firm's and measure your firm's performance in a realistic way. If you know the exact way to analyze the trend then you’ll be able to identify which direction your business is going.
- Larry Hart, The Stock Dork
What are the tools used for trend analysis?
In order to do trend analysis, you must decide on what segment, industry, or even asset you want to use. For example, you may want to look at the bond market. Once you make this decision, you also need to determine the period. There is no consensus on the actual amount of time for the movement to be considered a “trend.” As a result, this depends on the data availability and your purposes.
There are numerous statistical tools for trend analysis. One of the most basic ones is to simply plot the data points and visually establish the presence of a trend. Another option is to transform these data into moving averages that will eliminate fluctuations for better trend identification.
As a result, you must have access to the following:
- Raw numerical data
- Access to analysis software
Trend analysis examples
Trend analyses that use business information can be useful for both managers and stakeholders, including potential investors. For instance, you can perform a trend analysis using alternative data, such as website traffic for any given company.
The figure below shows the total website traffic in the last six months for company A, an online store that sells gifts. You can notice an uptrend during the holiday season, reaching the peak on the 20th of December.
After the first half of January, there has been a relatively horizontal trend. In other words, if you had a competing gift store, you could compare your performance to this company. Although intuitive, this example of trend analysis helps you predict future sales and performance or compare this company to a competitor’s activity.
The benefits of trend analysis are even more relevant when you are using alternative data. For instance, you could use foot traffic to identify an increase in the number of customers or point-of-sale transactions.
One of the most common trend analyses is when you are examining the share price of a financial asset to help with the decision-making process. For example, the figure below compares the share prices of two companies, X and Y, over one year.
Company X shows an overall uptrend over the past year with a small decrease in February. However, company Y had a horizontal trend for the first half months, after which it started to decrease. Generally, investors are more cautious when there is a horizontal trend because it is difficult to forecast when the price will change its direction and whether it will be up or down. In this case, the share price has a steady decrease, which will result in a loss if added to your portfolio.
Trend analysis is only as good as the information you have available. And even if you believe to have the most accurate information available, statistical noise along with randomness will always be present to distort your results. Therefore, you have to be very objective about your results and not let your sentiments drive your decisions. Furthermore, you have to combine different analytical techniques since no one method will provide you the most accurate result.
Alex Williams, CTO of FindThisBest
Company X’s increasing trend might indicate that this stock is a great addition to an investor’s portfolio, especially if you have a long-term investment strategy. However, other information should also be considered, both related to the company itself and the overall market and the economy. Trend analysis is only one tool that investors can use to identify the profitability of a given asset.
Overall, trend analysis has plenty of applications for business owners and investors. Given the breadth of the available data nowadays, the usefulness of trend analysis seems virtually limitless, especially when considering alternative data. Identifying trends before your competitors can bring you a considerable advantage, or you can simply aid your investment decision-making process to improve your portfolio returns.
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