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Analyze the Trends After determining which regions present a high reward-to-risk ratio, the next step is to use charts and technical analysis of macro trends. By looking at a long-term chart of the specific countries' economic indicators and broad stock market index, we can determine whether the corresponding stock market is in an uptrend and worth analyzing, or is in a downtrend, which would not be an appropriate place to put our money at this time.
These first two steps can help you discover the countries that would match your wants and needs for diversification. Look to the Economy The third step is to do a more in-depth analysis of the U. By examining the economic numbers such as interest rates , inflation, and employment, we can determine the current market strength and have a better idea of what the future holds.
There is often a divergence between the story the economic numbers tell and the trend of the stock market indexes. The final steps in macroanalysis are to analyze the major U. Both fundamental and technical analysis can be used as barometers to determine the robustness of the indices. The market's fundamentals can be determined by such ratios as price-to-earnings , price-to-sales, and dividend yields. Comparing the numbers to past readings can help determine whether the market level is historically overbought or oversold.
Technical analysis will help ascertain where the market is in relation to the long-term cycle. Use charts showing the past several decades and zone down the time horizon to a daily view. For example, indicators such as the day and day moving averages help us find the current market trend and whether it is appropriate for investors to be invested heavily in equities.
So far, our process has taken a macro approach to the market and has helped us determine our asset allocation. If, after the first few steps, we find that the results are bullish, there is a good chance a majority of the investment-worthy assets will be from the equities market. On the other hand, if the outlook is bleak, the allocation will shift its focus from equities to more conservative investments such as fixed income and money markets. Deciding on asset allocation is only half the battle.
The next integral step will help investors determine which sectors to focus on when searching for specific investments such as stocks and exchange-traded funds ETFs. Analyzing the pros and cons of specific sectors i. The process of analyzing the sectors involves tactics used in the prior approach, such as fundamental and technical analysis. In addition to the mentioned tools, investors must consider the long-term prospects of the specific sectors.
For example, the emergence of an aging baby boomer generation over the next decade could serve as a major catalyst for sectors such as health care and leisure. Conversely, the increasing demand for energy coupled with higher prices is another long-term theme that could benefit the alternative energy and oil and gas sectors. After the entire amount of information is processed, a number of sectors should rise to the top and offer investors the best opportunities.
The emergence of ETFs and sector-specific mutual funds has allowed the top-down approach to end at this level in certain situations. If an investor decides the biotech sector must be represented in the portfolio, they have the option of buying an ETF or mutual fund composed of a basket of biotech stocks.
Instead of moving to the next step in the process and taking on the risk of an individual stock, the investor may choose to invest in the entire sector instead. However, if an investor feels the added risk of selecting and buying an individual stock is worth the extra reward, there is an additional step in the process. This final phase of the top-down approach can often be the most intensive because it involves analyzing individual stocks from a number of perspectives.
An important aspect of individual stock analysis will be the company's growth potential over the next few years. Ideally, investors want to own a stock with a high growth potential because it will be more likely to lead to a high stock price.
Technical analysis will concentrate on the long-term weekly charts, as well as daily charts, for an entry price. At this point, the individual stocks are chosen, and the buying process begins. The Positives of the Top-Down Approach Proponents of the top-down approach argue the system can help investors determine an ideal asset allocation for a portfolio in any type of market environment.
Often a top-down approach will uncover a situation that may not be appropriate for large investments into equities. The ability to keep investors from over-investing in equities during a bear market is the biggest pro for the system.
It can include charting past returns to predict future performance, selecting the type of investment that best suits an investor's needs, or evaluating individual securities such as stocks and bonds to determine their risks, yield potential, or price movements. Investment analysis is key to a sound portfolio management strategy.
Understanding Investment Analysis The aim of investment analysis is to determine how an investment is likely to perform and how suitable it is for a particular investor. Key factors in investment analysis include the appropriate entry price, the expected time horizon for holding an investment, and the role the investment will play in the portfolio as a whole.
In conducting an investment analysis of a mutual fund, for example, an investor looks at how the fund performed over time compared to its benchmark and to its main competitors. Peer fund comparison includes investigating the differences in performance, expense ratios, management stability, sector weighting, investment style, and asset allocation.
In investing, one size does not fit all. Just as there are many different types of investors with unique goals, time horizons, and incomes, there are investment opportunities that match those individual parameters. Strategic Thinking Investment analysis can also involve evaluating an overall investment strategy in terms of the thought process that went into making it, the person's needs and financial situation at the time, how the portfolio performed, and whether it's time for a correction or adjustment.
Investors who are not comfortable doing investment analysis on their own can seek advice from an investment advisor or another financial professional. Key Takeaways Investment analysis involves researching and evaluating a security or an industry to predict its future performance and determine its suitability to a specific investor.
Investment analysis may also involve evaluating or creating an overall financial strategy. Types of investment analysis include bottom-up, top-down, fundamental, and technical. Types of Investment Analysis While there are countless ways to analyze securities, sectors, and markets, investment analysis can be divided into several basic approaches.
Top-Down vs. Bottom-Up When making investment decisions, investors can use a bottom-up investment analysis approach or a top-down approach. Bottom-up investment analysis entails analyzing individual stocks for their merits, such as their valuation, management competence, pricing power, and other unique characteristics. Bottom-up investment analysis does not focus on economic cycles or market cycles. Instead, it aims to find the best companies and stocks regardless of the overarching trends.
In essence, bottom-up investing takes a microeconomic approach to investing rather than a macroeconomic or global approach. The global approach is a hallmark of top-down investment analysis. It starts with an analysis of the economic, market, and industry trends before zeroing in on the investments that will benefit from those trends.
Top-Down and Bottom-Up Examples In a top-down approach , an investor might evaluate various sectors and conclude that financials will likely perform better than industrials. As a result, the investor decides the investment portfolio will be overweight financials and underweight industrials.
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