Top-Down Approach Explained

top down

If you have read my BIO or have seen my blog posts before, you may know that I use technical analysis to apply a top-down approach across all asset classes globally with the intention of  identifying trading and investing opportunities. Before I outline my trading plan and full-blown approach to markets in another blog post, I thought it’d be appropriate to define what a Top-Down Approach looks like. Hopefully by the end of this short post you will have a high level idea on the way I choose to analyze markets and an interest in exploring it further for yourself.

1. Analyze All Global, Liquid Asset Classes:

  • As a technician, I have the ability to look across all asset classes as long as there is enough liquidity and price data to do so. When the media is saying that it was a boring day/week/month on Wall Street, I often chuckle as they are so caught up in what the Dow is doing that they missed a huge move in the Australian Dollar or Oat Futures (yes, you heard me correctly, Oat Futures).
  • The main objective of this step in the process is to identify what asset classes I want to be involved in on a relative basis. If commodities are acting well and there is little action in equities or fixed income, then I want to be focusing on taking advantage of the opportunities in commodities.

2. Identify Broader Themes:

  • After I have identified which asset classes I want to be involved in, then I can identify what themes I am seeing across markets. For example, with sentiment towards Treasuries hitting extremes to start the year as well as the defensive nature of sector performance in equities, one could conclude that the market thinks that rates are going to stay lower for longer than most people are expecting. That is just one example of a theme I’d be looking for, but there are plenty of other themes out there that can and will develop depending on the time-horizon.

3. Determine The Best Way to Play The Theme:

  • After I have identified the asset class I want to be involved in as well as a broader theme present in the market, I can then drill down into individual securities that I feel are best positioned to take advantage of the identified theme. For example, in the case of rates staying lower there are a variety of ways to take advantage of the theme ranging from owning treasuries, other fixed income securities, or the defensive sectors of the equity markets. In many cases it is possible to drill down even further into a specific sector to find an individual name that is outperforming in that sector as well. In the case of rates staying lower, Duke Energy (DUK) was a good example of an individual security outperforming the broader market and the sector as well. For some, owning the utilities ETF may have been a more diversified play for them, but for the more aggressive market participant, selecting an individual security within that sector can provide additional returns; granted with more risk.

4. Portfolio Management:

  • The last step in the process is portfolio management. After determining the asset class to be involved in, the broader theme to play, and the individual security to play it with, then it is time to manage the portfolio of positions. This step includes everything from position sizing, correlation management, liquidity management and any other factor that’s built into your trading plan.

That is a high level look at what a Top-Down Approach is all about. Hopefully you learned something and are interested in exploring the topic more on your own. If you have any questions, comments or concerns, please feel free to reach out to me. Until next time.

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