The basic definition of stock price trend was given in the Dow Theory. In the capital market, technical analysis is a methodology used for forecasting the direction of prices on the basis of past market data. The efficacy of both technical and fundamental analyses is disputed, though, by the protagonists of the Random Walk theory that share prices are essentially unpredictable.
Following the Dow Theory, however, we have tried to measure the price trends on the basis of past data as far as available for both short term and long term. An upward trend line has a positive slope. A rising price combined with an increasing demand is very bullish. A downward slope has a negative slope. A declining price combined with an increasing supply is very bearish.
Charting trends: Even though trend lines are an important aspect of technical analysis, it is not always possible to draw trend lines on every price chart. A trend analysis tries to predict a trend like a bull market until data suggests reversal of the trend (e.g. bull to bear market). The trend analysis is helpful, because moving with trends, and not against them, will lead to profit for an investor. A trend is really nothing more than the general direction, in which a security or the market is headed.
Trends are not always easy to see. In other words, defining a trend goes well beyond what meets the eyes. In any given chart, prices do not tend to move in a straight line in any direction, but rather in a series of highs and lows. In a technical analysis, it is the movement of the highs and lows that constitute a trend. For example, an uptrend is classified as a series of higher highs and higher lows, while a downtrend is one of lower lows and lower highs.
The above figure 1 is an example of an uptrend. The Point 2 in the chart is the first high, which is determined after the price falls from this point. The Point 3 is the low that is established as the price falls from the high. For this to remain an uptrend, each successive low must not fall below the previous lowest point or the trend is deemed a reversal.
Types of Trend: As hinted before, there are three types of trend:
a. Uptrend, b. Downtrend, c. Sideways/Horizontal trends.
When each successive peak or trough is higher, it is referred to as an upward trend. If the peaks and troughs are getting lower, it is a downtrend. When there is a little movement up or down in the peaks and troughs, it is a sideways or horizontal trend.
To constantly make money in the stock market, one only wants to trade when stocks show a trend. It is estimated that stocks show a trend about 30 per cent of the time. The rest of the time they move sideways in trading ranges.
If you look at any chart that is in a strong uptrend, you will find that the pull-backs are short-lived. This gives you an excellent opportunity to buy the stock before it resumes the uptrend. Similar things happen with stocks in downtrends. If you find the downtrends are short-lived, this gives you an excellent opportunity to part with some stocks. In charting the prices, efforts are made to identify the trends when to buy and sell stocks.
Trend lines: A trend line is a simple charting technique that adds a line to a chart to represent the trend in the market or a stock. Drawing a trend line is as simple as drawing a straight line that follows a general trend. These lines are used to clarify to show the trend and are also used in the identification of trend reversals.
Trend lengths: Along with these three trend directions, there are three trend classifications.
A trend of any direction can be classified as a long-term trend, an intermediate trend or a short-term trend. In terms of the stock market, a major trend is generally categorised as one lasting longer than a year. An intermediate trend is considered to last between one and three months and a near-term trend is anything less than a month.
A long-term trend is composed of several intermediate trends, which often move against the direction of the major trend. If the major trend is upward and there is a downward correction in price movement followed by a continuation of the uptrend, the correction is considered to be an intermediate trend. The short-term trends are components of both major and intermediate trends.
Analysing trends: When analysing trends, it is important that the chart is constructed to best reflect the type of trend being analysed. To help identify long-term trends, weekly charts or daily charts spanning a five-year period are used by chartists to get a better idea of the long-term trend. Daily data charts are best used, when analysing both intermediate and short-term trends. It is also important to remember that the longer the trend is, the more important it is; for example, a one-month trend is not as significant as a five-year trend.
In the present analysis, in measuring the long-term trend, simple linear regressions would be run on past data where efforts are made to largely free them of seasonal fluctuation.
Data collection and structuring: A series of variable observations (DGEN Index) have been collected over 10 years' time. We would like to analyse as to whether time has any significant influence on the DGEN Index. In statistical terms, this is a determination of whether the probability distribution from which they arise has changed over time or not.
Dealing with seasonality: There are many instances where changes between different seasons of the year are a major source of variation in the Y variable. As with other exogenous effects, seasonal variation must be compensated for or "removed" in order to better discern the trend in Y over time. If not, little power may be available to detect trends which are truly present. We may also be interested in modeling the seasonality to allow different predictions of Y for differing seasons.
In structuring the data, we have considered the following:
a. We have fitted the trend keeping the data as it is - no seasonality is removed,
b. To remove seasonality, we have handled the data in the following manner :
i. Figures are rearranged on the basis of monthly moving averages,
ii. Monthly modal observations are considered, and finally,
iii. Annual observations - 12 monthly averages - are taken.
The contributors belong to the research team of Prime Finance and Investment Ltd. The views expr- essed here are of their own and not necessarily those of the institution they work for