Top-Down Analysis
Candlefocus EditorThe top-down approach starts with the macroeconomic factors, and helps investors save on time and effort in deciding their investments. It begins with an assessment of the economic trends and indicators, such as Gross Domestic Product (GDP) growth, inflation and employment figures, to identify sectors or industries that are likely to yield profitable investments. This view helps determine whether the economy is in an expansion or contraction phase and examine whether sectors are doing well or falling. Macroeconomic trends can place certain sectors or investments in favor or disfavor.
The next step in the top-down approach is to look at the data from individual companies and their performance. In this step, more particular assessments of a company’s financials, such as growth, profit margins, and valuation, are examined. Then, the sector that is providing the best return can be determined. However, this approach can risk ignoring sector-specific news or company-specific news.
After narrowing down suitable sectors and companies, the top-down approach calls for an assessment of the risks and rewards related to the possible investments. Investors will calculate the expected returns versus the possible risks associated with potential investments, and eventually decide on the course of action.
In summary, top-down analysis begins with the “big picture” before narrowing down the scope to individual securities. By leveraging macroeconomic and market data, investors may be able to quickly identify potentially profitable investments. However, the top-down approach may cause investors to overlook sector or company-specific news, and could lead to missed opportunities or even losses. As such, it is important to adhere to discipline and research when making an investment decision.