Learning Article : How to Leverage Sector Rotation to Outperform the Market

Amid the rabble of traders fighting to chase stocks, people tend to miss the bigger picture. Everybody is in this game to outperform the market. Looking for individual leaders is important, but in order to do that efficiently one must be ahead of the sector rotation curve to spot where the cluster of leaders is being generated.

Just like overall business cycles, sectors also have their trends linked to economic rationale. For example, overall growth outlook of any economy first impacts the Banking and Finance sector, followed by Infrastructure. The Metals and Mining sectors follow the commodity cycle, while the FMCG sector picks up on consumer confidence. While there is almost always an economic rationale behind these trends, there is an objective and efficient way to spot sector rotations.

1.Follow the movements of the weekly sectoral indices. Even better would be to create “Industry Groups” of companies with a similar business model and track the weekly performance of the group as a whole. Sectors gaining momentum will show big daily movement on their indices, indicating focus of institutional investors.

2.The validation of a sector’s strength comes from the leading stocks breaking out. If the rally in the index is accompanied by more than one leading stock showing breakouts, the sector is most likely preparing for a bull run. The price action must be accompanied by strong volumes, hinting that institutional investors are also betting on the same sector that you are going for.

3.More than one stock making their all-time high from the sector or the industry group is also a sign of valid momentum

4.Look for the earnings profile. If one of the prominent companies within the sector or industry group posts better-than-expected earnings and sales growth, it reflects the overall business environment for the sector. It is most likely the other companies will also post better-than-expected results. This will attract investors in the sector before you know it.

5.Shift your exposure gradually from a sector whose gains have plateaued for the time. Don’t hesitate to have multiple stocks from the same sector as it will increase the weight of the segment in your portfolio when you need it.

The recent rally in the Banking sector gave multiple signals. A strong action in the Nifty bank index was accompanied by strong volumes, meaning that institutions were showing interest in the overall sector. Not only that, leading stocks like HDFC Bank, ICICI bank, and Axis bank broke out with good price volumes and went on the make their all-time highs.

Related: Overview of FMCG Sector

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