Top Down investing looks at the overall economic climate when determining what to invest in. It looks at the overall view of economy before analyzing the different sectors. Stocks are not bought and sold based on simple indicators like changes in stock price. These are only temporary figures. The macro-economy is the main rational guide to top-down investing.
Almost all forms of investment take a top-down view of the economy in one way or another. For example, when looking at the macro variables of a stock, top-down views analyze how these price changes indicate how a company fits into the broader economy.
Buying stock without considering the broader global and domestic context is akin to buying a car without knowing your future needs, the kinds of roads you will be driving on or how long your commute is. You'll end up buying a middle-of-the-road car that can service all conditions tolerably. This is not the best fit for transportation, and it is not the best for investing. Knowing the basic macroeconomic trends driving both the global and national economy is essential to make sense out of stock purchases, especially long-term investments like certain bonds or commodities.
The alternative to top-down investing is looking at short-term price changes in stocks. This alone provides little usable information to the investor. There are many reasons a stock can go up or down drastically, including many non-economic variables, such as pending litigation.
An example of top-down investing works well with long-term bonds. If you are interested in bonds lasting years, and earning the long-term premiums associated with such bonds, then a detailed look at macroeconomic trends is necessary. You need to study the behavior of the dollar and its relation to other currencies like the euro or the yuan. You need to study the movements and announcements of the Federal Reserve, and the chairs of the House and Senate Finance Committees. A top-down view requires you to do your history homework, and see how monetary policies have worked in the past.
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