What is Trend Analysis?
Trend analysis is an analysis of the trend of the company by comparing its financial statements to analyze the trend of market or analysis of the future on the basis of results of past performance and it’s an attempt to make the best decisions on the basis of results of the analysis done.
Trend analysis involves collecting the information from multiple periods and plotting the collected information on the horizontal line with the objective of finding actionable patterns from the given information. In Finance, Trend Analysis is used for Technical analysis and Accounting analysis of stocks.
Types of Trend
#1 – Uptrend
An uptrend or bull market is when financial markets and assets – as with the broader economy level – move in the upward directions and keep increasing prices of the stock or the assets or even the size of the economy over the period. It is a time of booming where jobs get created, the economy moves into a positive market, and sentiments in the markets are favorable, and the investment cycle has started.
#2 – Downtrend
A downtrend or bear market is when financial markets and asset prices – as with the broader economy level – move in the downward direction and prices of the stock or the assets or even the size of the economy keep on decreasing over time. It is the time when companies shut down the operation or shrink the production due to a slump in sales. Jobs are lost, and asset prices start declining, sentiment in the market is not favorable for further investment, investors run for the haven of the investment.
#3 – Sideways / horizontal Trend
A sideways/horizontal trend means assets 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 the 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 examined the 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, is an indicator of expenses was booked twice in the first quarter. Thus the trend analysis in accounting is essential for examining the financial statements for inaccuracies, to see whether the adjustment of the certain heads should be made 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. 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 performance in Sales and Net profit over the years.
- We note that Sales has increased by only 16.3% over 8 years (2008-2015).
- We also note that the overall net profit has decreased by 20.3% over the 8 years.
For forecasting, estimated financial statements trend analysis is used for the head where no significant changes have happened. For example, if employee expense is taken 18 % of the revenue and considerable changes have not been made in the employees, then for estimated financial statements, employee expense 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 taking concluding the trend analysis.
- Trend analysis also involves finding patterns that are occurring over time, like a cup and handle pattern, head and shoulder pattern or reverse head and shoulder pattern.
- In technical analysis, it can be used in the foreign exchange market, 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.. 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. 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. for estimating future results.
What is the Importance of Trend Analysis?
- Trend analysis tries to find out a trend lie a bull market run, and make a 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 to an investor. The trend is the best friend of the traders is a well-known quote in the market.
- A trend is nothing but the general direction the market is heading during a specific period. 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. and bullish markets, respectively. There are no criteria to decide how much time is required to find out the trend; generally, the longer the direction, more is the reliable 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., 50 days moving average, 200 days moving average.
- While there is no specified minimum amount of time required for a direction to be considered a trend, the longer the direction is maintained, the more notable the trend.
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 dynamics.
The trend analysis in accounting can be used by management or the analyst to forecast future financial statements. Following blindly can turn out to be dangerous if a proper analysis of the past event is not done.
This article has been a guide to what is Trend Analysis and its meaning. Here we discuss how Trend analysis works in Accounting & Technical analysis along with practical examples. You can also learn more from the following resources –