The concept of trend analysis plays an important role in the financial world. In essence, trend analysis is a method used to predict future price movements during the course of a security by examining the historical performance of that security. Trend analysis can be used in many different markets and securities, but it is most commonly used in stock markets, where investors and traders attempt to anticipate future movements of the stock prices.
A popular form of trend analysis is the “relative strength index,” also referred to as “RSI.” The RSI utilizes past price movements of a security and calculates an index based on the levels of overbought or oversold the security may be in the present. RSI uses a specific formula and complicated calculations, but the general idea is to compare the period of time a security has been going up in value, to the period of time it has been going down. This ratio then tells the investor how strong the current trend is, relative to the past direction of the price.
More specifically, when the RSI crosses above a certain mark, it indicates that the security is overbought and therefore may be due for a correction lower. On the other hand, a cross below a mark may indicate that the security is oversold, and therefore may be due for a rally higher. If the RSI is near the neutral 50 mark, it likely indicates a consolidation period for the security in question, with the trend of prices being generally sideways.
The main advantage of the RSI is that it is mathematical and reliable, not relying on any sort of discretion or subjective judgment. The RSI also provides a useful gauge of when a security’s momentum is starting to slow down, and should thus be used in conjunction with other technical indicators.
Another popular trend analysis approach is the “two-lows-plus-a-high” technique. As the name implies, this method involves finding the two recent lows in the price of a security, and then buying the security when the price reaches an amount higher than the two lows. This technique is usually used in conjunction with volume analysis, as the combination of these two factors provides the best gauge of trending prices. This technique usually works best in mid-to-long-term trends, as it can identify the stage of a trend (i.e. beginning or ending) before it becomes obvious to other investors.
The two-lows-plus-a-high technique, while similar to the RSI, can provide a more conservative and effective entry point when getting into a trade. This is because, by waiting for prices to exceed prior lows, the risk of entering into a short-term correction is reduced significantly.
The last type of trend analysis technique we will discuss is called the “trendline-breakout strategy”. This method involves determining an established trend by drawing lines which follow the high and low points of the price action. Finding a strong trend can be tricky, but this method helps to simplify the process by analyzing the trend by connecting consecutive highs and lows on the graph. When the price breaks out of this line, it usually indicates that a major price movement is taking place, and potentially opens up a new trading opportunity.
Trend analysis is an essential tool for any investor or trader. By understanding the various techniques that can be used to analyze price trends, one can gain valuable insight into the markets and be better prepared to identify future opportunities. The important thing to remember is that trend analysis should not be used as the sole source of information when making decisions, but rather it should be used in tandem with other technical indicators and analysis.
