A trend is an important change in a given market, product, or elsewhere over time. Just as with all economic statistics, however, it is advisable not to jump to any conclusion based upon one single survey or report. Trends are indicators, and as such, they must be taken in conjunction with other data. This means that understanding how to interpret trends will help you to make more informed decisions.
Understanding what constitutes a trend is not an easy task. To begin with, a trend can take anywhere from several months to several years. The longer the period of time that a trend lasts, the more reliable the trend itself is. This means that longer periods between consecutive big price increases (the so called ‘bear market’ – after market participants began consolidating their investments to minimize risk) imply lower prices, while short periods (like the ‘Bull markets’ – when there were plenty of buyers) imply higher prices.
So how do you use a trend line to connect 2 data series? One approach is to plot the maximum and minimum prices over a given period of time against each other. Another approach is to use a moving average, which connects the minimum and maximum points along the trend line. Still another way to connect the trend lines is to draw them on a log-log scale. When you make use of either a moving average or a straight line, the slope of the line can also be plotted against the corresponding trend line. In this case, slopes of zero represent a steady upwards trend, whilst slopes of positive values represent a downward trend.
Now, there are many different ways in which to utilise trend analysis. For instance, some investors focus on short-term trends. They look to pick out small price changes within a longer-term trend and to utilise this information to make a profitable trade. Alternatively, some investors look to cover more of the market, looking to catch a bull market when it is about to turn (i.e. ‘picking a trend’).
However, trend analysis is not simply a matter of identifying which way a market is going to move. In fact, trend analysis isn’t even about predicting which way a market is going to move at all. Market trends are largely driven by forces outside of any trader’s control. Therefore, trends are rarely predictable over any length of time. This is why trend trading strategies make use of more sophisticated statistical analysis techniques to predict future movements within the market more reliably.
One of the most common methods of trend analysis is known as the Alexander Elders method, named after its creator, Dr. Alexander Elders. The technique makes use of a mathematical equation to predict future prices based on past prices and market trends. The equation states that if you take the slope of the price curve against a particular time period, and subtract it from the current price, you will get the predicted direction of the trend. While this is certainly a useful way to identify possible trend directions, bear in mind that the trend may reverse almost immediately when the price gets back to its starting point. Therefore, trends are best used as indicators of market direction, and not as guarantees of their success.