The economy is always changing. What was most important to investors a month ago could be at the bottom of their list right now. That’s why WooTrader doesn’t weight all of its screeners equally all the time. We’re constantly changing the weight of each data point to fit the current state of the market.
Sectors of the economy work the same way. What’s popular now may not be sought-after in a month or two.
But first, understand this: Somewhere around 50% of a stock’s movement is based on it’s sector. Deere (NYSE:DED) may be heading south for some reason related to the company but a big portion of its movement is probably related to the overall market and its sector. If its competitor, Caterpillar (NYSE:CATC) is seeing less than desirable movement in its stock, there’s a good chance that Deere is doing the same thing. In fact, many investors invest in baskets of stocks in the same sector or an ETF that tracks a specific sector. This is called sector rotation trading.
What’s the Strategy?
Think of sectors just like stocks. You could take a value investing approach. Sectors that are underperforming the market will likely catch up at some point. This is called mean reversion and you can profit from it. Whatever are the most beaten down sectors, allocate some resources to it—either by purchasing some stocks in the sector or an ETF.
At the same time, you may limit your exposure to sectors that are over-performing. Mean reversion will likely move them lower in the not-so-distant future.
You can also look more closely at the state of the economy. When the markets are challenged, expect investors to pump money into consumer staples like food, healthcare, agriculture, and energy. If the economy can’t do anything but go up, technology stocks will likely outperform. There’s plenty of ways to put together a sector rotation strategy. Just be careful.
If you subscribe to the theories of famed investor Warren Buffett, you’ve heard him say that individual stock picking for the short term, or market timing, aren’t likely to work. And the statistics back him up. It’s extraordinarily difficult to time the market.
That doesn’t mean you can’t take a more conservative approach. Sector rotation investing isn’t an all or nothing thing. You could simply up your portfolio weighting of sectors you believe are poised to outperform and reduce your weighting of sectors that may underperform.
Before you invest real money, consider paper or virtual trading your strategy for a year. Read our article on stock trading simulators to learn how to virtually trade your strategies. If you can’t first make money in a virtual environment you won’t make money in a real environment either. Also consider tax and fee implications. The more you trade, the more it costs you.