There are several decisions that must be made prior to entering a trade or investment. One must first decide what to invest in. Then the choice of when to invest comes and finally where to exactly enter. Most people decide what to invest in due to a recommendation from a broker, a friend, or even from television or print media. Any casual observer of the stock market can easily see that the stock market goes through a cycle of bullish and bearish movements. What many do not know is that there is also a cycle with sectors that also go through these same movements.
What you need to realize about the markets is that roughly 50-60% of a stock’s move is directly related to the movement of the broad market. There are exceptions, but as the saying goes, a high tide will raise all boats in the marina. This means that in a bullish market, most stocks will rise, and they will similarly fall in a bearish one.
There will be different participation in these bullish or bearish markets depending on the sector the stocks belong to. The sector movement and trend can influence up to 30-40% of a stock’s movement. That only leaves about 10-20% of the movement attributed to the company’s fortunes itself.
When we are selecting trades or even long-term investments, we want to be diversified but also invest with focus and purpose. We should start with a top down approach where we analyze the markets first and determine the most probable trend direction.
Once that is done, then the focus changes to choose the sector or sectors that are likely to move the best in that market environment.As mentioned earlier, the stock market follows a sector rotation model that can be used both to identify opportunities in the markets as well as letting us know where we are in the economic cycle. As seen below in the figure from John Murphy’s www.stockcharts.com website, sectors in the stock market outperform the broad market in different economic cycles.
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