Sector Rotation

These markets also show a variable, rotating, degree of risk. This is an advantage to understanding something about Sector Rotation. And this, admittedly, has limited use for trading in a single market or security and on shorter timeframes. Yet knowing there is a shift in risk appetite/aversion can always be an added advantage. The best runs come when sector strength moves from one group to another. The worst conditions come when sectors are in a trading-range. The idea is to get on the right side of major moves. For instance, generally the currencies are considered the most risky while bonds are consider the least. Following these markets with an eye towards risk can be a great help to developing a long vs short investment bias: for instance, an uptrend in bonds might have a currency trader looking for short positions to trade. (I will get into this more when I get to risk analysis in the coming section on Money Management.)
As you can see, this helps with following certain trading rules. For instance: finding the trend to follow it and knowing the probabilities to defining your risk.
There are simple to very sophisticated models for following the rotation. David Vomund’s Basic Rotation and Style Index strategies border on what I would call simpleton models. They find the six month leaders and buy the top two for two weeks to a month then re-evaluate. Then, on the other end of the spectrum, Russ Koesterich takes alpha vs beta in the Capital Asset Pricing Model while focusing on volatility. And, of course, there is The Stovall Rotation Strategy. And, finally and for the chartist, there are look-ups websites, even using ETFs: The tool spots the relative performance of all sectors for any point in time, and any timeframe. The sliding scale at the bottom of the chart is adjustable. The chart can even be customized with specific ETFs., the marketwatch tool is a different way of looking at relative performance….using bars instead of plotted lines. There’s no visual overlay like there is with the tool, nor can the ‘start’ date be moved to any point in time. And, a trader’s own tickers can’t be plotted. However, it is possible to ‘drill down’ into individual industries, and then even into individual stocks. This considerably greater detail is useful if trying to pick a specific stock.