What Is a Top-Down Analysis?
Top-down analysis is an investment analysis method that involves investors looking at high-level investment data before looking at more detailed data. After taking a high-level look at potential areas of investment, an investor progressively narrows down the field of investment opportunities by looking at progressively more detailed-oriented data. This method often is used by investors looking to invest internationally, who start by assessing the overall economy of a country, helping them eventually select potential industries and then companies within those industries in which they would like to invest.
Often, investors use a top-down analysis to assess which sectors of a country’s economy promise the highest growth for a specific period of time. Investors look to see which sectors of a country’s economy shows signs that they will outperform the rest of the country’s economy. Once a sector has been determined to be a good investment, more data is used by an investor to determine which specific companies that reside in that sector are projected to perform the other companies in the sector.
Proponents of top-down analysis for investments argue that the approach helps save valuable time. Instead of sifting through financial statements for dozens or hundreds of companies, the top-down analysis approach allows investors to look at smaller pools of data first. Investors who are looking to hold stocks for shorter periods of time might value this approach, since they need to make investment decisions quickly and regularly.
Day traders use top-down analysis to not only choose which investments to make, but also to decide at what point they should buy. For example, a trader might look at larger, daily trends of a company’s stock to assess if it is a good investment opportunity. After deciding to invest in the company’s stock, the investor will then look at how the stock trends at 15 minute increments through the day, projecting what specific time of day would be optimal to purchase the stock, as well as when would be optimal to sell the stock later.
Some debate exists about whether top-down analysis is a superior way of assessing investment opportunities versus bottom-up analysis. Both methods involve a process known as fundamental analysis, which involves investors collecting data from various sources, such as company financial statements, industry trend data and a country’s overall economic health. Proponents of bottom-up analysis argue that some companies are diamonds in the rough, or that they can thrive in industries that are otherwise failing. A top-down analysis approach would lead potential investors away from such companies, since the industry data would not be attractive.
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