What is Top Down and Bottom Up approach in stock investing?
While performing the fundamental analysis of companies, two of the most common strategies to research stocks that are used by investors
In this post, you’ll learn what exactly is top down and bottom up approach, how they work and which one may be more suitable to you.
Top down approach
Have you ever heard any investor/analyst saying something like- “The electric vehicle industry looks particularly promising now. The industry is growing at a fast pace and I should invest in this industry”.
Well, here the investor is following the top down approach to find stocks.
In the top down approach, the investors first look into the macro picture of the economy and later work down to research the individual stocks.
The overall steps involved in
For example, let’s say you studied that the European economy is growing at a very fast rate. Next, when you looked further into the European market, you found that especially the biotechnology industry in outperforming. And finally, you researched some appealing stocks in that industry to invest. This is the top down approach for stock investing.
Here, you start with the big picture and ultimately move down to find the suitable investing opportunity.
A few of the major areas where the top down analysts pay attention are economic growth, GDP, monetary policy, inflation, prices of commodities, bond yields etc before moving into the specific industry study.
The biggest advantage of
However, one of the major
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Bottom up approach
This approach is exact opposite of the
Bottom up approach tries to study the fundamental of the company regardless the market conditions, industry or the macroeconomic factors. While performing the bottom up approach, the investors studies how fundamentally strong the company is by focusing on its revenues, earnings, financial ratios, products/services, sales growth, management etc.
The key here is to find the potentially strong company which may outperform the industry and market in future. If the fundamental factors are good, then regardless of what the industry is doing, the bottom up investors will pick such companies to invest.
The biggest advantage of the
On the other hand, one of the cons of
Top down and bottom up are entirely different approaches to analyze and invest in stocks. However, both have their own advantages and disadvantages.
Anyways, both approaches have their own effectiveness and hence, difficult to say which one is better. Moreover, it also depends on the knowledge and preference of the investor. My final advice would be to better try out both the approaches and find out which one suits you the best for your investment strategy.
Hi, I am Kritesh, an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting