What is a Top-Down Analysis
Top-down analysis looks at the "big picture" first, and then analyses the details of smaller components. An investor who uses top-down analysis typically begins by analyzing the global economy. They then assess macro trends within economies that they believe have the best opportunities. Sectors that are poised to take advantage of those macro trends are then evaluated. Finally, individual stocks within favorable sectors are selected. Top-down analysis can also be used by technical analysts to get a more comprehensive view of a security’s price action.
BREAKING DOWN Top-Down Analysis
Top-down analysis may be used by a trader who uses technical analysis as part of their trading strategy. A day trader may first analyze daily or weekly charts to determine a security’s longer-term trend as well as its significant support and resistance levels, and then move to a smaller time frame to establish a good entry point. For example, if a security is trending higher on the daily chart, and there is bullish momentum on the hourly chart, a trader who is using top-down analysis could then move to a 15-minute chart and find a good entry point for their long position.
Putting Top-down Analysis Together
- Global Analysis: Investors can assess the health of the global economy by analyzing the gross domestic product (GDP) of both developed and emerging markets. Investors should also consider a country’s geopolitical risks to ensure it is safe to invest. Strong GDP growth over several years is usually an indication that an economy is performing well. For instance, China’s economy appears to be healthy, growing 6.7% in 2016 and 6.9% in 2017.
- Macro Trend Analysis: Macro trends can be determined by looking at specific areas of a country’s economy that are showing strong signs of growth. For example, the rising middle class in China has led it to become one of the world’s largest importers of food. To analyses macro trends further, investors could look at the specific foods that are getting imported, such as beef and dairy products. (To learn more, see: Cashing in on Macroeconomic Trends.)
- Sector Analysis: Once investors have identified promising macro trends, they can analyze sectors that are well positioned to take advantage. For example, after determining there is growing demand for beef and dairy foods in China, the investor would analyze the consumer goods sector, specifically the processed and packaged foods, meat products and farm products subsectors.
- Stock Analysis: Investors using top-down analysis then look at specific stocks in the subsectors that have the most potential to meet increasing demand for meat and dairy products in China. A mix of fundamental and technical analysis can help decide what stocks to buy. For instance, Investors, might look for stocks in the meat consumer goods subsector that have a market capitalization over $1 billion and have recently crossed above their 200-day moving average.
(For further reading, see: A Top-Down Approach to Investing.)