Trend Spotting: How Successful Investors Find the Next Big Thing

In “Back to the Future Part II,” Biff Tannen gets rich by using information from the future to make can’t-lose sports bets in the past. While Biff and his special brand of inside information are pure fiction, it is nonetheless a perfect allegory for investment trend spotting.

Investment trend spotters seek to gain insight into the future and profit from that knowledge. In reality, the investing world is littered with the carcasses of schemes and systems for divining the future. Wall Street will always have some latest and greatest way to beat the system and make easy money. They work for a while before collapsing under the weight of their own success.

What Is a Stock Trend?

Stock prices move up and down on an hourly, daily, and weekly basis. For example, Apple stock closed at $119 a share on Nov. 26, which was $12 more than on Dec. 16. However, months earlier on June 24, the price was $90, and on Jan. 2 it was $79. That tells us Apple has been trending upward despite its dip on Dec. 16.

A trend is the long-term direction in which a stock price is moving, either up or down. That does not mean it won’t have swings in price during the course of a day, a week, or a month — it will. If we look at the price of Apple and General Motors stock on Nov. 26 and Dec. 16, you will see Apple has gone down in price and GM has gone up.

Date Apple General Motors
Nov. 26, 2014 $119 $26
Dec. 16, 2014 $107 $31

You can’t tell if that is a trend until you pull back a little further and see their prices over a longer period of time. In the longer view, it becomes obvious that Apple is in an upward trend and GM is in a downward trend.

Date Apple General Motors
Jan. 2, 2014 $79 $41
Nov. 26, 2014 $119 $26
Dec. 16, 2014 $107 $31
Dec. 19, 2014 $112 $33

Investors interested in Apple would have been eager to buy the company’s stock on Dec. 16 even though it had been dropping in price for a couple of days, because the trend of the stock over the course of the year was up. Proof of that showed up a few days later when the price regained $5 of its value.

Range vs. Trend

Trends come in all shapes and sizes. Day traders will look to capitalize on trends that last a few hours or a few days; they buy and sell stocks hoping to guess right on what the market is going to do. Trend investors look at longer periods of time to find trends to capitalize upon.

Looking at General Motors’ price over an even longer period of time, we see it has been trending upward since July 2012 when it was below $20 a share. In an even longer view, going back to November 2011 when GM emerged from bankruptcy priced at $34 a share, the stock is flat.

Even though GM’s overall trend has been flat, investors are still trading their stock for a profit because they have identified its price range as being between $19 and $40. That means even if the trend remains flat, they can still make money by buying shares when they dip and selling them as they approach their peak within that range. They will be investing based on shorter-term trends within GM’s range.

The Winds of Change

Savvy investors look at other trends to combine with stock-price trends to find the next big thing. In stock investing terms, a big thing is any stock that outperforms the market as a whole. That means if the stock market goes up in value by 10%, any stock that goes up in value by more than that has outperformed the market.

Identifying stocks that will outperform the market requires looking at other trends, such as the economy as a whole or plans a company has for a new product, service, or market.

The Oracle of Omaha himself, Warren Buffett, is not known as a trend investor. He traditionally invests in stocks based on their price versus their value. When he finds a stock that is selling for $10 and the company has assets worth $15 a share, he buys it regardless of whether it is trending up or down.

He invested that way for decades until 1988, when he broke his own rule and started buying Coca-Cola stock. Coke had been flat or trending upward slowly for years, but never really outperforming the market. The reason was they were in a death match with Pepsi and there was no room for additional growth.

Buffett read the newspapers and knew the collapse of the Soviet Union and looser trade restrictions in Asia meant there would soon be a whole new market for Coca-Cola products. He was right. Coke quickly opened bottling plants in Russia and China and the price of the stock skyrocketed from $27 in 1988 to as high as $74 by 1998.

Trends, it seems, come in two forms: intrinsic, tied to a stock’s value, and extrinsic, such as market factors that can influence the price of a stock. What extrinsic trends do you see impacting stocks in 2015? Leave your thoughts in the comments.

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