The Sector Edge
Trading Sector Funds Using Statistics
by John P. Twardy
Ever thought of trading sector funds? Here's a method that'll give you an edge on the market.
Sector fund analysis and trading always seem to require tools other than the standards used by the average stock trader. Because sector funds deal with a specific family of stocks, which are associated with a specific sector of the economy, at a specific time in the economic cycle, several layers of complexity are added to the analysis problem. Thus, while typical analysis packages provide moving averages, trendlines, and more, these methods aren't enough when applied to sector fund analysis.
SECTOR FUNDS DEMYSTIFIED
What are sector funds? Sector funds are a subset of the mutual fund industry. Many mutual fund companies offer sector funds as part of their portfolios. There may be 30 or 40 sector funds available as investment vehicles from any one brokerage firm. Each of these funds invests in one particular sector of the economy, as diverse as real estate, biotechnology, insurance, wireless communications, gold, and so on. The individual sector funds hold stock in various companies that make up a portion of that sector.
If you invest in any sector fund, your investment will be concentrated in one narrow industry sector. This select portion of the market may not follow the broader market trends, and at times will actually go against the trending market. Since investments in sectors represent such a narrow focus on the stock market, they tend to inherently represent a larger potential risk (and hence, reward) to the investor.
Why would you want to invest in a fund that imitates a portion or sector of the economy? The US business cycle typically takes about 48 to 60 months to complete. During this time, the economy goes from peak to peak or trough to trough for a complete expansion and contraction. During this cycle, certain business areas grow and others contract.
During an expansion period, there is an increase in demand for consumer goods. So by investing on areas of the economy that appear to be favorable at the current point in the business cycle, you could realize gains that exceed those you might get from investing in, say, an index fund. Sector fund traders often say that if you pick the right sector, you can make a lot of money in a short time.
Every trader or investor is looking for a means to obtain an edge on the market. Just look at the number of investment tools available. While there is a multitude of stock analysis programs and trading systems, they are all based on the same basic data - price, volume, and time. Every system has its own twists and turns, using second and third derivatives of this data, but they are still based upon the three basic data types provided by the exchanges. No one has a secret database that contains the magic factor, because it simply does not exist.
For effective sector funds analysis, traders need an indicator that provides rankings based on expected performance. Here's one solution that appears to hold up, at least in a historical perspective.
...Continued in the October issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the October 2004 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2004, Technical Analysis, Inc.
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