What is Trend Analysis?

Trend analysis involves collecting the information from multiple periods and plotting the collected information on a horizontal line to find actionable patterns from the given information. In Finance, Trend Analysis is used for Technical analysis and Accounting analysis of stocks.

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Types of Trend

#1 – Uptrend

An uptrend or bull market is when financial markets and assets – as with the broader economy-level – move upward and keep increasing prices of the stock or the assets or even the size of the economy over the period. It is a booming time where jobs get created, the economy moves into a positive market, sentiments in the markets are favorable, and the investment cycle has started.

#2 – Downtrend

Companies shut down their operation or shrank the production due to a slump in sales. A downtrend or bear market is when financial markets and asset prices – as with the broader economy-level – move downward, and prices of the stock or the assets or even the size of the economy keep decreasing over time. Jobs are lost, asset prices start declining, sentiment in the market is not favorable for further investment, and investors run for the haven of the investment.

#3 – Sideways / horizontal Trend

A sideways/horizontal trend means asset prices or share prices – as with the broader economy level – are not moving in any direction; they are moving sideways, up for some time, then down for some time. The direction of the trend cannot be decided. It is the trend where investors are worried about their investment, and the government is trying to push the economy in an uptrend. Generally, the sideways or horizontal trend is considered risky because when sentiments will be turned against cannot be predicted; hence investors try to keep away in such a situation.

What is the Use of Trend Analysis?

It is used by both – Accounting analysis and technical analysis.

#1 – Use in Accounting

Sales and cost information of the organization’s profit and loss statement can be arranged on a horizontal line for multiple periods and examine trends and data inconsistencies. For instance, take the example of a sudden spike in the expenses in a particular quarter followed by a sharp decline in the next period, which is an indicator of expenses booked twice in the first quarter. Thus, the trend analysis in accounting is essential for examining the financial statements for inaccuracies to see whether certain heads should be adjusted before the conclusion is drawn from the financial statements.

Trend Analysis in accounting compares the overall growth of key financial statement line itemKey Financial Statement Line ItemFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more over the years from the base case.

For example, in the case of Colgate, we assume that 2007 is the base case and analyze the sales and net profit performance over the years.

  • Sales have increased by 16.3% over eight years (2008-2015).We also note that the overall net profit has decreased by 20.3% over the eight years.

For forecasting, estimated financial statements trend analysis is used for the head where no significant changes have happened. For example, suppose employee expense is taken 18 % of the revenue, and considerable changes have not been made in the employees, then for estimated financial statements. In that case, employee expenses can be taken as 18 %.

Internal use of the trend analysis in accounting (the revenue and cost analysis) is one of the most useful management tools for forecasting.

#2 – Use in Technical Analysis

An investor can create his trend line from the historical stock prices, and he can use this information to predict the future movement of the stock price. The trend can be associated with the given information. Cause and effect relationships must be studied before concluding the trend analysis.

  • Trend analysis also involves finding patterns occurring over time, like a cup and handle pattern, head and shoulder patternHead And Shoulder PatternThe head and shoulders (H&S) pattern are one of the most widely used chart patterns by traders in the stocks and Forex markets. Traders can identify the pattern from the three tops that form, with the middle indicating the highest price trend and the end of an uptrend.read more, or reverse head and shoulder pattern.It can be used in the foreign exchange marketForeign Exchange MarketThe foreign exchange market is the world’s largest financial market that decides the exchange rate of currencies.read more, stock market, or derivative marketDerivative MarketThe derivatives market is that financial market which facilitates hedgers, margin traders, arbitrageurs and speculators in trading the futures and options that track the performance of their underlying assets.read more in technical analysis. With slight changes, the same analysis can be used in all markets.

Examples of Trend Analysis

  • Examining sales patterns to see if sales are declining because of specific customers or products or sales regions;Examining expenses report claims for proof of fraudulent claims.Examining expense line items to find out if there are any unusual expenditures in a reporting periodReporting PeriodA reporting period is a month, quarter, or year during which an organization’s financial statements are prepared for external use uniformly across a period of time in order for the general public and users to interpret and evaluate the financial statements.read more that require further investigation;Forecast revenue and expense line items into the future for budgetingBudgetingBudgeting is a method used by businesses to make precise projections of revenues and expenditure for a future specific period of time while taking into account various internal and external factors prevailing at that time.read more for estimating future results.

What is the Importance of Trend Analysis?

  • The trend is the best friend of the traders is a well-known quote in the market. Trend analysis tries to find a trend like a bull market run and profit from that trend unless and until data shows a trend reversal can happen, such as a bull to bear market. It is most helpful for the traders because moving with trends and not going against them will make a profit for an investor.Trends can be both growing and decreasing, relating to bearishBearishBearish market refers to an opinion where the stock market is likely to go down or correct shortly. It is predicted in consideration of events that are happening or are bound to happen which would drag down the prices of the stocks in the market.read more and bullish marketA trend is nothing but the general direction the market is heading during a specific period. There are no criteria to decide how much time is required to determine the trend; generally, the longer the direction, the more is reliably considered. Based on the experience and some empirical analysis, some indicators are designed, and standard time is kept for such indicators like 14 days moving averageMoving AverageMoving Average (MA), commonly used in capital markets, can be defined as a succession of mean that is derived from a successive period of numbers or values and the same would be calculated continually as the new data is available. This can be lagging or trend-following indicator as this would be based on previous numbers.read more, 50 days moving average, and 200 days moving average.While no specified minimum amount of time is required for a direction to be considered a trend, the longer the direction is maintained, the more notable the trend.

Conclusion

The trend is a friend, is a well-known quote in the trader’s fraternity. The trader makes a good profit by following the trend, and trend analysis is not an easy task. It required eyes on details and an understanding of the market dynamicsMarket DynamicsMarket Dynamics is defined as the forces of market constituents responsible for the shift in the demand and supply curve and are therefore accountable for creating and reducing the demand and supply of a particular product.read more.

The trend analysis in accounting can be used by management or the analyst to forecast future financial statements. Following blindly can be dangerous if a proper analysis of the past event is not done.

This article has guided what Trend Analysis is, and its meaning. Here we discuss how Trend analysis works in Accounting & Technical analysis and practical examples. You can also learn more from the following resources –

  • Variance Analysis FormulaVariance Analysis DefinitionRegression Analysis ExcelCost Volume Profit Analysis