Trends and fashions come and go in life and in the stock market, and that’s what sector rotation is all about. One type of stock goes is “hot” today but “not hot” a month later. This change is a normal part of the stock market because it works in cycles. And it might sound mysterious, but it’s possible to understand it. Or, better yet, you can learn to profit from it.
To make money from sector rotation, you’ll want to get a brokerage account. Specifically, you’ll need an account that allows you to buy and sell exchange-traded funds or ETFs. These are similar to mutual funds, and some of them represent stock-market sectors. So let’s delve into what this strategy means and how you can trade it.
Let’s start simple. A sector is a part of the economy. And as an investor, you can also view a sector as a part of the stock market. For example, there’s the energy sector of the economy. It includes companies that work with oil, natural gas, and coal—such as Exxon Mobil (XOM) and Chevron (CVX).
Another example is the financial sector, which mainly comprises of banks such as Bank of America (BAC) and Wells Fargo (WFC). However, the financial sector also includes non-bank companies that deal with managing money on a large scale. For instance, insurance companies like American International Group (AIG) and The Travelers Companies (TRV) tend to be part of the financial sector.
As I explained earlier, the stock market involves cycles. The investing community will favor one sector for a while. Then they’ll dislike that sector and favor a different sector for a time. In other words, the market “rotates” in and out of the various sectors at different times.
Rotations can last for weeks, months, or even years. When the stock market is feeling “risk-on,” investors tend to rotate into riskier stocks. These riskier investments include the technology, retail and online retail, consumer discretionary, and (sometimes) biotechnology sectors. When investors are feeling “risk-off,” they tend to flock to less risky sectors. These less risky sectors include utilities, healthcare, and consumer staples.
We saw this sector rotation in action during the financial crisis of 2008–2009. The “high flyers” like technology stocks had made tremendous gains until the financial crisis. And the investing community had rotated into riskier stock sectors. However, they rotated out of those sectors quickly during the crisis. Then, they rotated into sectors that felt safer.
Most well-known stock-market sectors have ETFs that represent them. Here are a few examples:
These ETFs aren’t guaranteed to track or follow the sectors perfectly. However, they usually do a pretty good job of following the general movements of their respective sectors. You can check with your broker to see if they allow you to buy and sell these ETFs.
At any given time, some of these ETFs will be out of favor, and their prices will be down a lot. Others will have a lot of favor from investors and be relatively expensive. Some of them, meanwhile, will just be neutral.
The idea with sector rotation is to sell the heavily-favored sector ETFs if you own them. Then you can buy the sector ETFs that are out of favor. Hopefully, in due time, those out-of-favor sectors will regain investor favor and go back up. That’s the time to sell them and start looking for less favorable sectors to park your investable money.
It takes guts to buy stock-market sectors that most investors are selling. However, that’s the crux of the “buy low, sell high” philosophy. Billionaires like Warren Buffett and John C. Bogle became very wealthy with this approach.
Rotating in and out of stocks requires you to check the comparative prices of sector ETFs. And you’ll also need to gauge market sentiment and what’s in and out of favor. Most of all, you’ll need the courage to buy what’s not popular at the moment. If you have what it takes for sector rotation, however, you could prosper in the long term—regardless of what’s hot and what’s not.
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