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Top-Down Analysis Definition
Top-down analysis is about seeing the big picture concerning the sectors or industries where investors want to make investments. After the identification of stocks and sectors, the next step involves observing the in-depth information as well as financial statements in order to make the final call for investment.
A Little More on What is Top-down Analysis
A person who considers using the top-down analysis approach is interested in taking a wider look at the international economy. Then, they determine and measure huge trends going on in the economies, and select the ones offering the most of the opportunities to grow. Industries falling in those macro trends are assessed, and ultimately, the selection of individual stocks lying in the feasible sectors or industries is made.
Key points to remember:
- Top-down analysis commences with the consideration of macro trends instead of stocks.
- Top-down analysis is based on the analysis of global trends, sector analysis, and finally, stock analysis on an individual level.
- Top-down analysis approach is considered in technical analysis for analyzing trends for larger time periods prior to restricting them with shorter time periods.
Elements of top-down stock analysis: Global analysis
Any investor who opts for top-down analysis commences with an analysis of global trends. In order to ascertain the financial health of the economy, the investor can refer to the gross domestic product of developed as well as developing economies. Besides, it is important for investors to identify if the company has any geopolitical risks involved. If the GDP of a nation is constantly growing, it indicates its good performance. In case, the investor wants to invest in a specific location, then he or she may use the global analysis for limiting between nations falling in that location.
For instance, if an investor wants to invest somewhere in Asia, he or she can apply the GDP and GDP growth filter for identifying Asian nations that have shown GDP growth in the last 2 years. Or, the investor can search for the highest Asian economy having the best GDP growth, which is China as per the 2019 statistics.
Elements of top-down stock analysis: Macro trend analysis and sector analysis
The following steps include the macro trend analysis and sector analysis. One can ascertain macro trends by seeing particular regions of a nation that show growth on an amazing level. For example, the growing middle class in China has made it one of the biggest food importers in the international market. For having an in-depth look at macro trends, investors can observe which food items are being imported more, and making a comparison in staple food such as beef, dairy, pork, oil, etc.
After doing their research on macro trends, investors can make analysis of sectors that seem to be beneficial in terms of investment. For instance, once the investor has identified that the demand for beef in China is more, and will continue to grow, he or she can observe the consumer goods sector, especially focusing on the packaged foods, farm products, meat products, etc. The investor can either opt for entering the value chain at an early stage, and emphasize on importers of commodity goods and the countries those are importing goods to China, or they can opt for moving up the value chain, and focusing on the local food processors who seek huge margins for importing goods to China. An investor can identify from where to exploit by using margins and sector-level performance levels.
Getting down to the stock level in top-down stock analysis
Once a specific sector in a feasible region has been identified, investors use top-down analysis approach for further taking a glance at particular stocks available in sub-sectors that have the highest potential. For instance, the investor seeks profitable organizations that meet rising demand for food items in China. They can use an amalgam of technical and fundamental analysis for identifying the type of stocks that need to be bought. For example, the investor can aim for stocks falling in the meat consumer market having a market capitalization of more than $1billion, and have just gone beyond the moving average of 200 days. In case, more than one company meets these requirements, then the investors should go for fundamental analysis of their financial statements for comparing stats associated with the return on invested capital or any other criterion.
Top-down Analysis in Technical Analysis
Top-down analysis, considering technical analysis, offers insights on the prices of securities varying from larger time period to shorter ones. If you are a day trader, then you should focus on analyzing charts on a daily or weekly basis in order to find out if the security follows a long-term trend followed by its support and resistance measures, and then make a significant move to a narrower time frame for locating a feasible entry point. For instance, in case, a security trends more on the daily chart, and the hourly chart shows bullish movements, a trader who is following the top-down analysis can opt for a 15-minute chart, and identify a feasible entry point for his or her long position.
References for “Top-Down Analysis”
Academic research for “Top-Down Analysis”
Bottom up and top down: Analysis of participatory processes for sustainability indicator identification as a pathway to community empowerment and sustainable …, Fraser, E. D., Dougill, A. J., Mabee, W. E., Reed, M., & McAlpine, P. (2006). Bottom up and top down: Analysis of participatory processes for sustainability indicator identification as a pathway to community empowerment and sustainable environmental management. Journal of environmental management, 78(2), 114-127.
SIGMA: A Framework for Image Understanding-Integration of Bottom-Up and Top-Down Analysis., Matsuyama, T., & Hwang, V. S. S. (1985, August). SIGMA: A Framework for Image Understanding-Integration of Bottom-Up and Top-Down Analysis. In IJCAI (Vol. 9, pp. 908-915).
Simple, effective performance management: A top‐down and bottom‐up approach, Muras, A., Smith, T., & Meyers, D. (2008). Simple, effective performance management: A top‐down and bottom‐up approach. Journal of Corporate Accounting & Finance, 20(1), 65-73.
A top-down analysis: Determining photovoltaics R&D investments from patent analysis and R&D headcount, Breyer, C., Birkner, C., Meiss, J., Goldschmidt, J. C., & Riede, M. (2013). A top-down analysis: Determining photovoltaics R&D investments from patent analysis and R&D headcount. Energy Policy, 62, 1570-1580.
A holistic risk analysis method for identifying information security risks, Spears, J. L. (2004, November). A holistic risk analysis method for identifying information security risks. In Working Conference on Integrity and Internal Control in Information Systems (pp. 185-202). Springer, Boston, MA.
Integrating bottom-up into top-down: a mixed complementarity approach, Böhringer, C., & Rutherford, T. F. (2005). Integrating bottom-up into top-down: a mixed complementarity approach.
Combining bottom-up and top-down, Böhringer, C., & Rutherford, T. F. (2008). Combining bottom-up and top-down. Energy Economics, 30(2), 574-596.
Experiential learning for undergraduates in economics and finance: A true top-down investment fund, Dolan, R. C., & Stevens, J. L. (2010). Experiential learning for undergraduates in economics and finance: A true top-down investment fund. Journal of Financial Education, 120-136.
Combining top-down and bottom-up in energy policy analysis: a decomposition approach, Böhringer, C., & Rutherford, T. F. (2006). Combining top-down and bottom-up in energy policy analysis: a decomposition approach.
A top-down approach to multiname credit, Giesecke, K., Goldberg, L. R., & Ding, X. (2011). A top-down approach to multiname credit. Operations Research, 59(2), 283-300.