Top Down Trading is a trading philosophy first described by Jesse Livermore. So in this blog post, I’ll share some current examples of top down trading, and how you can use it in your trading decisions today. Sound good?
So first we’ll look at what top down trading is. And then I’ll show you some examples of how I’m using top down trading every day to improve my stock picks and investment decision making.
Now let’s get into it…
Introduction to Top Down Trading:
The main idea behind top down trading is that a rising tide lifts all boats. So if you can find where the tide is going up… then… you can also find stocks that are going up. Easy enough, right?
That means top down trading is concerned with finding the best stocks within the best sectors within the best industries in the market. Instead of bottom fishing for bargains, you look at what’s working and let the momentum do the work for you. Got it?
The concept for top down trading is pretty simple. But it will help if you see some examples.
Current Examples of Top Down Trading:
Some of the premium stock picks I’ve been looking at lately lend themselves well to top down trading. And by following what’s happening in the sector ETFS (like we did in the March 2014 ETF Update) you can really get a feel for when your stocks are battling upstream or riding the market currents.
So here are some examples of top down trading:
- Energy top down trading example: SPY —> XLE —> XOP —> ESV … In this case ESV is the stock in question, and I would be inclined to buy it when I see strength in the broad market (SPY), the energy sector ETF (XLE), and finally the oil and gas exploration ETF (XOP). By buying my favourite energy stock when the sector is gaining momentum I’m more likely to make money on my trade quickly. Make sense? And even if it’s a longer-term investment it’s still nice to maximize your chances of being in the green right away.
- Homebuilder top down trading example: SPY —> XLB —> XHB —> PHM … In this case PHM is the stock in question, and top down trading would dictate that I look for strength in the homebuilders, the material section and the market at large before buying PHM… I’ve refrained from buying PHM this week because the home builders have been so weak. So you see top down trading can influence both your buying and selling decisions .
- Technology top down trading example: QQQ —> XLK —> SMH —-> TSM … In this case TSM is the stock in question and we’re looking for strength in the Nasdaq, technology and semiconductor sectors before looking to allocate money based on a top down approach. This has been a beauty this week.
- Insurance top down trading example: SPY —> XLF —> KIE —> SYA … In this case SYA is the insurance stock I want to buy, but before allocating more cash I’m always careful to look for sympathetic strength in the financial industry and insurance sector before putting money to work
After looking at the top down trading examples above, you should see the basic approach behind these top down trading ideas. And you should be able to use this top down trading approach yourself to improve your capital gains. But hey…
You still might be wondering how long term fundamental investors can use this top down trading strategy. And I would’t blame you…
Top Down Trading vs. Bottom Up Analysis:
Fundamental and long term investors are big proponents of bottom-up analysis. And they should be! Bottom up analysis works really well for finding outstanding companies. But when you’re looking to put new money to work, it also pays to use top down trading.
By using top down trading you maximize your chances of winning right out of the gate. So personally I like to use top down trading to compliment my entries and exits in my highest conviction long term investing ideas. Make sense?
By using this hybrid approach I focus on the best fundamental ideas and maximize my chances of cashing in.
And By The Way: If you’re looking for more tips and techniques to improve your investment approach I encourage you to sign up for my free ebook below. It’s short and easy to read, plus it will help you improve your approach to stock markets.