"What do you want to achieve or avoid? The answers to this question are
objectives. How will you go about achieving your desired results? The answer to
this you can call strategy."
- William E Rothschild
Strategically managing your investments offers several advantages. It gives a framework for decision-making that can remove emotions that so often interfere with good judgment. By following a set strategy, you can obtain more predictable and repeatable results than guesswork. With the proper strategy, you have a better chance at profits than chasing the latest hot stock tip that often fizzles. Time management is easier with known steps versus endless market research. Plus, objective strategies allow for backtesting or historical simulation that builds in-depth understanding.
One type of trading strategy called sector rotation shifts positions between the various areas of the market, attempting to always get positioned for profits. Exchange traded funds (ETFs) make the process easier by covering everything including stock market industrial sectors (such as health care and technology), stock market styles (think large cap, small cap), bond flavors (Treasury, high yield, muni), and international markets (bond and stock).
Most sector rotation strategies fall into one of three main philosophical camps:
- Use the economic cycle as a fundamental guide
- Use technical criteria to choose sectors that are beaten down
and have the most room to rise
- Use technical criteria to choose sectors with the most momentum
Correctly anticipating the current position in the business cycle is part
art, part science and undoubtedly easier in hindsight. Furthermore, sectors may
not follow such as orderly progression with today's "risk on/ risk off"
Technical strategies are simpler to apply and can discern relevant information from the price action and mathematical constructs. Examples of technical criteria can be complex indicators such as the Relative Strength Index (RSI), or as simple as the Rate of Change (RoC) of each ETF.
Certainly personal preference will play a role in choosing a type of strategy. Bargain hunters will appreciate buying low while trend-followers gravitate to the current leaders.
Data is also available to help make an objective decision. Back-testing can give an idea of how strategies performed in the past. While it's true that past performance does not determine future results, we can still use back-testing to eliminate non-performing strategies, and gain experience with potential trading candidates.