Identify and Benefit from Sector Trends
Step Three: One simple tool used to build a disciplined strategy is trend analysis. Let’s illustrate the simplicity of this. If you connect two dots on a chart and the resulting line rises from left to right then the trend is up. If the line falls from left to right then it is a down trend, and if the line is flat it is a sideways trend. Your strategy could be as simple as buying when the trend line is up and selling when it moves down. I use this example when teaching investors simple technical analysis. It really can be that simple, but our minds won’t allow us to accept the simplicity. Remember this rule - KISS - keep it so simple, so you can act!
Sector trend is a simple way to analyze the market by breaking it down. To keep this example simple, let’s take the 10 sectors which make up the S&P 500 index. We could set up a strategy to track each one independent of the index. If you look at Basic Materials and see an uptrend while the trend of the S&P 500 is down, we could make a strategy for taking advantage of this discrepancy. The point is the 10 sectors can be watched and invested in, independent of the index. If the trend is truly your friend, the trend of the sectors following the trend of the major index is where we are likely to make the most money. This allows us to develop a strategy accordingly.
I am partial to sector trend analysis because it allows me to know if I am fighting the major trend by investing in a specific sector. The example above, investing in Basic Materials when the trend of the major index is down, takes on an element of greater risk. This would prompt more research to determine if the risk of such a trade is warranted. As you can see, we are developing checks and balance for putting our money at risk in any area of the market.
Take some time to learn the different sectors and make a list. Then look at charts of each sector to determine the trend of each. We can then move on to the next step which is developing a strategy for entry, exit, and target.
This process will allow us to measure the risk of each trade versus the potential reward. The more knowledge we gain before we put our money to work the better investor we will be. Remember that knowledge neutralizes emotions and that is a key point for a disciplined strategy for investing money.
Benefit from sectors with a disciplined strategy! Tomorrow we will cover Step Four: Keep it simple with sectors and ETFs.
