Financial Trend Analysis

Trend analysis is a technique employed by technical analyst in the financial industry to predict the future movements of a given asset. They employ historical data to determine the direction of the trend. The goal of this procedure is to identify attractive investment opportunities that are currently showing an upward trend; and of course, to identify downtrends too, so investors can get out before losing money.

Perhaps one of the disadvantages of trend analysis is that past behavior is not always consistent in the future, in other words, whatever the price of a given security did in the past is not necessary an indication of what it will do in the future because there are a lot of other significant elements that come into play when it comes to determining the value a financial security.

Trend analysis involves the collection of information from multiple time periods and plotting the information on a horizontal line for further review. The intent of this analysis is to spot actionable patterns in the presented information. In business, trend analysis is typically used in two ways, which are as follows:

• Revenue and cost analysis: Revenue and cost information from a company’s income statement can be arranged on a trend line for multiple reporting periods and examined for trends and inconsistencies. For example, a sudden spike in expense in one period followed by a sharp decline in the next period can indicate that an expense was booked twice in the first month. Thus, trend analysis is quite useful for examining preliminary financial statements for inaccuracies, to see if adjustments should be made before the statements are released for general use.
• Investment analysis. An investor can create a trend line of historical share prices and use this information to predict future changes in the price of a stock. The trend line can be associated with other information for which a cause-and-effect relationship may exist, to see if the causal relationship can be used as a predictor of future stock prices. Trend analysis can also be used for the entire stock market, to detect signs of an impending change from a bull to a bear market, or the reverse. The logic behind this analysis is that moving with a trend is more likely to generate profits for an investor.

When used internally (the revenue and cost analysis function), trend analysis is one of the most useful management tools available. The following are examples of this type of usage:

• Examine revenue patterns to see if sales are declining for certain products, customers, or sales regions.
• Examine expense report claims for evidence of fraudulent claims.
• Examine expense line items to see if there are any unusual expenditures in a reporting period that require additional investigation.
• Extend revenue and expense line items into the future for budgeting purposes, to estimate future results.

When trend analysis is being used to predict the future, keep in mind that the factors formerly impacting a data point may no longer be doing so to the same extent. This means that an extrapolation of a historical time series will not necessarily yield a valid prediction of the future. Thus, a considerable amount of additional research should accompany trend analysis when using it to make predictions.

Advantages of Trend Analysis:

(a) Possibility of making Inter-firm Comparison:

Trend analysis helps the analyst to make a proper comparison between the two or more firms over a period of time. It can also be compared with industry average. That is, it helps to understand the strength or weakness of a particular firm in comparison with other related firm in the industry.

(b) Usefulness:

Trend analysis (in terms of percentage) is found to be more effective in comparison with the absolutes figures/data on the basis of which the management can take the decisions.

(c) Useful for Comparative Analysis:

Trend analyses is very useful for comparative analysis of date in order to measure the financial performances of firm over a period of time and which helps the management to take decisions for the future i.e. it helps to predict the future.

(d) Measuring Liquidity and Solvency:

Trend analysis helps the analyst/and the management to understand the short-term liquidity position as well as the long-term solvency position of a firm over the years with the help of related financial Trend ratios.

(e) Measuring Profitability Position:

Trend analysis also helps to measure the profitability positions of an enterprise or a firm over the years with the help of some related financial trend ratios (e.g. Operating Ratio, Net Profit Ratio, Gross Profit Ratio etc.).

Disadvantages of Trend Analysis:

(a) Selection of Base Year:

It is not so easy to select the base year. Usually, a normal year is taken as the base year. But it is very difficult to select such a base year for the propose of ascertaining the trend. Otherwise, comparison or trend analyses will be of no value.

(b) Consistency:

It is also very difficult to follow a consistent accounting principle and policy particularly when the trends of business accounting are constantly changing.

(c) Useless in Inflationary Situations:

Analysis of trend percentage is useless at the time of price-level change (i.e. in inflation). Trends of data which are taken for comparison will present a misleading result.

Types of trend

Uptrend

It is the trend when financial markets and assets move in upward directions, resulting in an increase in the price. It is usually the time of boom in the economy, where overall sentiments are favorable.

Downtrend

In the downtrend or the bear market, the economy, financial markets, and assets prices move in the downward direction. It is the time when companies shrink operations and overall investor sentiment is not favorable.

Sideways / Horizontal Trend

In this, the assets prices or the broader economy-level are not moving in any direction, rather are moving sideways. This means, moving up for some time and then down on the same level.  It is a risky movement as investors are unsure of what will happen to their investment.