Swing Trading For Dummies by Omar Bassal CFA

Author:Omar Bassal, CFA [Bassal, Omar]
Language: eng
Format: epub
ISBN: 9781119565116
Publisher: Wiley
Published: 2019-04-30T00:00:00+00:00

Understanding the basics of the top-down approach

The top-down approach allows you to understand the condition of the overall market, which is valuable because the majority of securities follow trends in the overall market. For example, if the stock market is dreadful and hits new lows every few weeks, you probably won’t find many great candidates to buy. On the other hand, if the market is roaring to new highs, choosing winning stocks is much easier because the wind is at your back.

Using this approach, you begin by determining if the market is overvalued or undervalued. Now, I wish I could tell you that the market is so efficient that when it’s overvalued, it quickly snaps back and becomes properly valued. Or that when it’s undervalued, it promptly snaps back and becomes properly valued. Sadly, this isn’t the case. Markets can become and remain over- or undervalued for significant periods of time — even years. For that reason, you evaluate whether the market is overvalued or undervalued on a fundamental basis, but put greater weight on the technical chart to swing trade.

After evaluating the market, you question whether the industry is likely to outperform or underperform the market. Finally, you look at the individual security to see whether its statistics are impressive enough to warrant investment.

Top-down analysis involves two specific steps:

Determine the state of the overall market — is it cheap or not and what direction is the trend?

This step allows you to determine whether the overall market is cheap or expensive. As a swing trader, you don’t have time to call analysts, survey government data, and build an economic model that perfectly captures all information that may influence an overall market. Even if you did have the time for all that, I’ve never seen proof that such complexities improve forecasting abilities (my apologies to my statistics and economics professors). You look at some basic measures of market valuation, but at the end of day you must put greater weight on the technical picture to tell us whether to trade or not.

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