MARKET TIMING
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.
Return to October 2004 Contents
