There are two primary forecasting methods used in the financial markets. The first method, fundamental analysis, relies on financial data such as earnings reports, price/earnings ratios and news releases in order to predict the future market direction. The other method, technical analysis, relies solely on chart patterns and other indicators based on price data. The theory behind technical analysis is that all relevant fundamental information is built into the price data.
A company's earnings data is one of the major pieces of information considered in fundamental analysis. One important statistic is the earnings yield, which shows the percentage earned on every dollar that was invested in a company's stock. A high earnings yield is considered a signal of strength. The inverse of the earnings yield is the price/earnings or p/e ratio. This ratio expresses the market price of a share/earnings per share.
According to technical analysis, various chart patterns are thought to repeat constantly and therefore serve as indicators of future price direction. Some of these patterns are as follows:
Double bottom: The price hits a market low, rallies back slightly, and bounces off the low again. This signals a rally.
Double top: Like the double bottom, except the price reacts twice off a market high. This signals a decline.
Head and Shoulders: The price makes a top, declines and then rallies again to form a higher top, then declines and rallies again to form a lower top. The trend line connecting the two lows formed by the declines is the "neckline." When the price breaks through this line after the third top, it signals a decline. When this pattern is reversed and the price breaks above the neckline, it signals a rally.
Support and Resistance
Support and resistance are concepts that fall under the category of technical analysis. These are significant price levels calculated based on previous price highs and lows. Basically, if prices have reacted several times at the same price level, that price level is considered significant in determining future reactions. Traders sometimes use techniques such as Fibonacci projections (38.2%, 50% and 61.8% of a price range) in order to determine additional support and resistance levels.
Many technical indicators use price data to generate market forecasts. Arguably the most popular is the moving average convergence divergence (MACD). This indicator subtracts a long period exponential moving average from a shorter period exponential moving average. Then it creates another exponential moving average of the one that was just created, which is referred to as the signal line. When the original moving average crosses above the signal line this indicates strength and when it crosses below the signal line this indicates weakness.
Some studies have suggested that financial markets repeat in certain recurring cycles. One example is the business cycle, which measures growth and decline over five stages. Another example is the Kondratiev Wave, which claims to identify super cycles lasting from 50 to 60 years in capitalist economies. Some people feel that if they can identify which part of a cycle the market is currently in, they can accurately forecast future performance.
Types of Forecasting Methods
Forecasting is the process in business marketing and web development of determining what the business market that you are engaged in looks...
How to Project Revenues
Revenue Forecasting Techniques; Comments You May Also Like. ... How to Market New Skin Care Products Projects. From anti-aging lotion to organic...
Role of Sales Forecasting in Marketing
Role of Sales Forecasting in Marketing. Sales and marketing are interrelated disciplines that require careful planning and execution. ... Methods of Market...
Quantitative and Qualitative Forecasting Tools
Quantitative marketing research produces larger samples than its counterpart: qualitative research. Hence, ... Revenue Forecasting Methods.
The Fundamentals in Forecasting for Beginners
A forecast is a prediction of a company's future financial performance presented in numerical format, usually in the form of spreadsheets. When...
What Is Strategic Forecasting?
Strategic forecasting techniques are evolving. ... planners must identify the costs and investment needed to succeed. They must estimate the marketing budget,...
How to Choose Methods of Sales Forecasting
How to Choose Methods of Sales Forecasting. ... Forecasting is the process in business marketing and web development of determining what the...
Types of Demand Forecasting
Forecasting and Market Analysis Techniques. Running a business means responding to constant changes in supply and demand. The savvy business professional seeks...
Why Is Demand Forecasting Important?
Demand forecasting is paramount to the future success of any ... moves in the opposite direction of price. ... and quantitative methods...