Investors who are looking for a stock market trading strategy are certain to come across the basic ways to make investment decisions: bottom-up and top-down.

With the bottom-up approach, you focus on understanding what’s going on, rather than trying to predict what happens next. You could call this descriptive finance. You delve into earnings, dividends, sales, balance sheet structure, competitive advantages and so on.

From there, it quickly becomes evident that there’s a lot you don’t know about the risks in the investments you are considering. So you try to design a portfolio in which the risks offset each other.

Using the top-down approach (which you might call predictive finance), you downplay what’s going on now and try to figure out what happens next. You may zero in on trends in stock prices, the economy, interest rates, gold and so on. You may disregard most details. Or, you may focus on a single key trend, event or detail, such as the Y2K scare that gripped the world in late 1999, avian flu, the future of the electric car or the next dramatic development in technology.

In any one year, top investment honours often go to a top-down advisor. When enough people offer opinions about the future, somebody is bound to get it right. But nobody gets it right every time. Anybody who did would eventually acquire a measurable share of all the money in the world, and nobody ever does that.

That’s why there’s a lot of turnover in the top ranks of top-down investors. One bad guess can ruin a previously enviable record.

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The advantage of working from the bottom up

Over periods of five years and beyond, top investment honours mostly go to a member of the bottom-up group. That’s partly because bottom-uppers tend to make fewer big mistakes. This lets their gains accumulate. This also leads to longer holding periods, which provide greater tax deferral and lower brokerage costs.

The top-down approach appeals to beginning investors, when they have not yet learned how little they know. (And that’s a better time to do it, when you have little money to invest and can’t do yourself much harm.) By the time they build up enough of a stake to begin serious investing, most advisors and investors have settled on a mix of top-down and bottom-up. As years pass, successful investors tend to put more weight on bottom-up. They like the way it cuts risk.

Sometimes, a top-down idea acquires way too much influence on way too many investors. A good example is the intense interest that built up over the European debt crisis and a possible eurozone economic collapse, if not a worldwide collapse. Month after month, in every edition of every newspaper you could find one or more articles delved into how that might occur, and the devastating financial results that would follow.

Much the same sort of commentary flared up over the issue of America’s “fiscal cliff” before a grudging resolution was hammered out in Washington.

This widespread attention tends to get priced into the market, as traders say. In other words, investors react to this kind of potential calamity by paying a little less for investments than they otherwise would. As a result, you can buy good investments for less money.

You still hear a fair amount of negative commentary on Europe these days, but it’s old and not especially convincing. Now some commentators add that France could be the next Greece in a few years, if it fails to make needed changes and so forth.

To put it another way, if the risk of an economic collapse in France—or another “fiscal cliff” crisis in the U.S.—tempts you to sell all your stocks and go into cash (as traders say), keep one thing in mind: you’re not the only person who knows about that risk.

COMMENTS PLEASE&#8212Share your investment knowledge and opinions with fellow TSINetwork.ca members

Do you consider yourself a “bottom-up” investor who picks stocks on their individual merit after careful research? Or have you tried a “top-down” approach and invested in a stock you thought would benefit from a key trend or event? Was the investment successful? Let us know what you think.