What is the top down approach??

By: ispeculatornew
Date posted: 06.03.2009 (5:00 am) | Write a Comment  (5 Comments)

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stockIt’s something that you hear about when reading about stocks, the top down approach as well as the stock picking. What are they and which should you go by??? This post will be a little introduction to both methods and who uses them.

First off the stock picking. This one is the easiest to understand as most investors (especially those not working in the investment field) will usually go through this. It is basically when you hear or read about a company, decide to read about it, either the financial statements, or analyst recommendations, etc. Then, you decide to either invest or not in the company. Fairly straightforward isn’t it? There are obviously many things to be aware of when using stock picking, especially those that clog all of their picks in the same sector. Think you know who will find the next diamond or gold mine? Want to invest in the company? That is fine. But just remember that you do not want your retirement to hold on finding that one company. Ideally, you would not be investing too much in one specific field or industry.

Now let’s move on to the top down approach. This where knowledge of the economy helps. Basically, someone using this method would be looking at data about the world economy. You can then find specific areas of growth or scenarios. Let’s say you predict a rebound of the US economy in late 2009. Then, depending on the stage of the economic recovery you are targetting, specific industries or sectors usually perform better in those periods and you will be looking to invest in those areas. Once you have determined your scenario and industries, you will be looking at the specific companies that you expect to do well in this scenario. It is certainly not an easy or quick process to go through but you can usually be a lot more diversified and perhaps invest in companies that you never would have thought of initially. You could for example imagine that the US government will be investing a lot in the health care industry and getting a more central and public system under way. If that is the case, chances are that companies that can provide a more universal IT system that will replace each state’s system. In that case, you would probably be looking for an IT company that can provide a solution. In the same way, the energy policies of the Obama administration tend to promote green energy sources so you would think that solar energy companies could do very well in this environment. These are just a couple of examples but I think they illustrate how the top down approach might require more analysis but can provide with better picks in the long term…

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5 Comments

  1. Comment by Simpless — June 4, 2009 @ 7:49 am

    Great post. How do you think stock-picking advice from Jim Cramer should be taken? hahaha I personally think he’s giving a crappy show and some average investor can easily get fooled by him!!!

  2. Comment by Sophie — June 4, 2009 @ 8:03 am

    Interesting! What kind of criteria would you propose to select the right stock or at least a few of them? What are the things that you need to get aware of?

    Thanks!!

  3. […] Intelligent Speculator describes the top down approach. […]

  4. Comment by IS — June 6, 2009 @ 1:45 pm

    @Simpless – yeah, not a big fan of Jim Cramer although I think he sets himself in a position where he cannot really win, people will always be able to bring back his bad shots because he puts himself out there…

  5. Comment by IS — June 6, 2009 @ 1:46 pm

    @Sophie – I think you are looking at the ways the economy will evolve and how different companies are positioning themselves accordingly. I think the “green trend” is a good example as some companies still are not paying attention and it could cost them later on…

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