Beginner investors have a hard time choosing which stocks they should invest in. Some simply focus on blue-chip companies that are dominant in the market, while the others follow the stock investments of well-known investors in the industry. In terms of market analysis, there are 2 common approaches to choose from: the top-down and the bottom-up approach. In this article, we would focus on the top-down approach to market analysis.
What is top-down market analysis?
The top-down approach is a market analysis strategy which considers first the macroeconomic factors before breaking down to more specific components. It involves analyzing the economy globally to pin-point countries that have an economic advantage, and then breaking down into profitable industries. After looking at the overall picture, analysts are able to recognize companies that have the capacity to outperform the market. Through this approach, investors are able to pick out the most profitable stocks to invest in.
This approach is called a top-down market analysis because it starts by analyzing the market from the top – that is, the global economy. This is done by comparing various economic components such as the gross domestic product or GDP for the past few years, previous cases of inflation, interest rates, unemployment, and cash flows of the country. This is important in order to filter which countries are economically stable and healthy for investments.
Once analysts have a certain country picked out, they proceed to analyze which industries are currently performing well in terms of profits and are speculated to improve more in the future. With a certain industry in mind, analysts look for specific countries in that industry that is capable to outperform the market. From this point, they further analyze stocks that could potentially become successful investments.
Example of a top-down approach
Let us say that a new investor wanted to pick out his first stocks, but he does not have a certain company in mind. He applies the top-down market analysis to see which stocks are best to invest in. After comparing several countries, he found out that Country A have the most stable economy with favorable conditions. So looking at Country A, he targets down the industries that are currently doing well. He manages to find that the IT industry is currently the most profitable. With that, he compares different IT companies until he was able to find a company that he thinks will do even better in the future. After some research, he was able to point out some stocks that have the possibility to turn into good investments.
Importance of top-down market analysis
A top-down approach is best for investors who doesn’t have a particular sector, company, or stocks in mind. It works by looking at the bigger picture until it narrows down to smaller and more specific components. This approach helps a lot in picking out stocks that have a great possibility to become profitable instead of just picking out random stocks without a basis of profitability.
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