Day Trade Reports - Understanding Sectors And How To Trade Them
If it is raining in Los Angeles, chances are that it might be raining in its tinsel town district of Hollywood
. Likewise, if LA were forecasted to see a long hot summer in 2012, so would Hollywood. Logically, it makes sense and more importantly, it tells us that the classification is an important aspect for any analysis.Without that it would be extremely strenuous to conduct studies, let alone analyze them. This also applies to financial markets, where classifications are profusely employed. Sectors or sector wise classification is one of such exercise.
For the uninitiated, a sector, in finance or economics, refers to a set of businesses that are involved in the buying and selling of similar goods and services. Most times, these businesses (within a sector) are in direct competition with each other. To carry out studies or analysis, each stock is generally classified into a market sector. For example, stocks of Apple or Microsoft would appear in Information Technology sector, likewise shares of Bank of America would appear in financials sector, where it is further categorized into the banking sector and so on. For US stock markets, there are about ten such sectors, which are further divided into 21 industries. The most heavily traded sectors are usually found in form of indices. For example, Dow Jones U.S. Financials, S&P Health Care Index, etc. The sector wise distribution helps in analyzing a stock better, in terms of it performance and comparison to contemporaries or the overall sector. Analysts compare stocks within a sector on various fundamental and technical facets to device a trading approach that is best suited for a given period of time.
As to why is this important is because studies indicate that stocks in a specific sector behave similarly over a period of time. For instance, if economic conditions are poorin a region, then buying a car would largely be considered unaffordable. Needless to say this will directly impact the entire automobile sector.This creates a bearish sentiment over the majority of stocks in the sector, irrespective ofmake, brand value, popularity, type or past performance of the company. Clearly, selling stocks would be recommended, as most stocks can be expected to follow the suit to head southwards. This basically underlines that the collective behavior of stocks in a sector is not an intrinsic part of the companys health but rather is due to some external factors.
It also becomes easier for an investor to spot sectors that are doing relatively better or worse than others, not to mention itmakes the fairly vast stock data a lot more comprehensible for a general investor.It is quick and highly efficient way of stock analysis that can also provide you with instantaneous market sentiment over broader sectors.
Besides trading stocks in sectors that are doing comprehensively well or otherwise, it also provides other vital information for trading or investment. The sector wise distribution can also be used for diversification of trades. That is to say, if you are bullish or bearish on a particular sector then you can choose to invest in several stocks in the same sector or in a general index. This can greatly reduce your risk and increase your chances of profitability.
Another strategy to consider, especially for long-term investment purposes, would be sector rotation. It is a strategy involving moment of money from one sector to another in an attempt to beat the market. According to the sector rotation theory, certain sectors of business profit more in certain stages of economic cycle. The strategy emphasizes that simple arrangement of economic stages can provide a useful road map to traders to trade in respective sectors. It divides the economic cycles into four stages namely full recession, early recovery, late recovery and early recession. Thereby also indicating which sectors would do well in each respective stage. For example, supposing the market is in early recovery stage. When things start to pick up, consumer expectation will begin to rise, production will grow, interest rates would decrease and yield curve begins to get steeper. Then, historically conducted studies illustrate that investing in sectors of energy, basic materials or industrials would be highly beneficial. Likewise the other three stages of the economic cycle have their favorable sectors. The key here is to determine the stage the current market is going through and according apply sector rotation strategy and trade in those sectors.
In the end, it would be fair enough to say that classification of stocks into sectors greatly enhances a traders comprehensibility of immeasurable stock data. That in turn increases his ability to make better trading or investment decisions.
by: Gerald Rickman
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