Which Issues Should I Select for Investing?

When investing, the universe of potential investments is enormous. This means that some method must be used to cull out the investments, determining those most likely to outperform the markets. Usually, the investor only goes long investments or in cash, rarely short, although in the commodities markets, long one currency, for example, may be equivalent to being short the other. Let us look at some of the items you need to consider when choosing investment securities.

In the futures markets, selection is usually based on a ratio analysis of each future versus a basket of futures or against another investment vehicle. In the stock market, selection uses two different methods. The first method is the top-down method whereby the prospects for the market and sectors are first determined, the prospects for groups (such as industry groups or countries) are determined, and finally—after the decision is made that a particular market is favorable and certain groups are favorable for investment—specific stocks are selected from within the groups. This method is more common in fundamental analysis and in professional management of buy-and-hold portfolios where there may be little choice as to whether to be in the stock market or not. It is often called asset allocation, and the method we will look at is the observation of intermarket relationships.

The second method is the bottom-up method, whereby stocks are selected, usually based on their price behavior, but also on their earnings, cash flow, and general business prospects. This method is more technically oriented because it uses relative price strength as one of its primary selection criteria. By selecting stocks first, regardless of their group affiliations, the investor can assess what groups are performing well and whether the entire market is favorable or not. If few stocks come through the screens for performance, it is clear that the market is in difficulty, for example, and if many stocks meet the investment criteria, the market is favorable.

Source: Kirkpatrick II Charles D., Dahlquist Julie R. (2015), Technical Analysis: The Complete Resource for Financial Market Technicians, FT Press; 3rd edition.

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