Regardless of which method you use to choose your shares, be it technical analysis, fundamental analysis or gut feeling, the most successful share traders and investors adopt a similar approach when it comes to reviewing the market, that is, a…
Top-Down Approach.
A top-down approach refers to looking at the performance of the major global economies, such as the US and European markets. We then focus on the overall performance of our local market and see how it is performing in light of the other markets around the world. We then study the performance of the different sectors that make up our local market, such as mining or retailing. Finally, we compare and study the individual shares that make up the sectors.
By adopting this approach, we can gain a fair idea of how individual shares will perform in comparison to the larger markets around the world. Looking at the performance of just one company can be likened to studying just one tree in the forest. For example, looking at the graph of a particular share may show a sudden fall. Does this indicate bad news or an adverse shift in fundamentals within the company, or was the company simply caught up in a general market correction? It is important to understand what is happening to the forest and for that, broader measures are needed.
If studying the forest is important for the average investor or trader, it is vital for institutions and managed funds that have large portfolio holdings. The huge growth of the managed funds industry requires not only that all stock exchanges provide a broad benchmark to measure market movement, but several subindices as well, to show how each segment of the overall market is performing in relation to the whole.
To study the performance of different international markets, we use indices. An index is simply an arbitrary benchmark designed to measure the movement of some broad compilation of shares. Just as a datum is an arbitrary horizontal mark set to measure ocean tides, an index serves a similar function for an exchange: it shows whether the market tides are rising or falling.
It is for the exchange concerned to decree which shares or commodities are included in an index, how they are weighted (the basis for comparison between them) and what base-line is used initially to provide their benchmark. Once this figure has been set and the reference point established, then future movements will alter this figure up and down, in accordance with what is happening in the underlying markets.
The most popular Australian index is the All Ordinaries (All Ords). The All Ords is made up of approx. 260 companies. If the All Ords is rising, it means that the overall Australian economy is strengthening. Other popular indices include the ASX 200, which is a measure of the top 200 companies in Australia. Read the rest of this entry »
