A top down approach method is the act of seeking out securities by first looking at global economics, industry, and then individual companies as an investor looks for an excellent security to invest in.

Top Down Approach Meaning

There are several different factors that are involved in a top down approach model. The top down approach analysis tries to incorporate all of these factors to try and find a best fit on a security that an investor is seeking. The factors are as follows in order:

1) A top down investor will first look at the global economy as a whole when conducting a top down approach. Different global economies affect a firms pricing and competition. Currency exchanges can have a large effect on this competition and should also be considered. If a firm is experiencing a lot of difficulty in competing in a country it conducts a lot of business in it may not be the best fit for an investor to buy the security.

2) The next step in the top down approach model is for an investor to look at the local government and economic environment of the best fit country. The best indicators to test the surface are by looking at the gross domestic product (GDP). unemployment rates, inflation, interest rates, and the budget deficit of the local government.

3) All of the factors above indicate a specific industry in which the investor might need to choose based upon the type of investment needed. Some industries perform better in certain economic environments than others and based upon the conditions in steps one and two the right industry can be chosen. Industries might vary in thier growth, volatility, and life cycles.

4) The last step is for an investor to choose a specific company within the industry. Investors want to pick a company that is considered in excellent condition. This can be performed by doing a thorough financial analysis and by gaining opinions of several analysts who are familiar with the industry.

Top Down Approach Example

The world economy is currently in a recession. However, Dwight has some money sitting in a bank account that he would like to invest in order to earn some sort of return. Dwight decides that he is going to follow a top down approach to investing to decide what security he should invest in and add to his portfolio. Dwight first decides that he would like to invest domestically in the United States as he believes the U.S. will bounce back sooner than most other countries. He then decides that he would like to invest in the oil and gas industry because it has historically been known to be a relatively recession proof industry and less volatile. After observing several different companies Dwight decides that he wants to invest in Chevco Inc. which has historically performed better than its peers even in recessions. Note that using this approach does not always account for the desired return or deviation that an investor may want to take on or receive.