Sector Analysis

Sector analysis is used by investors to assess the performance of stock and analyze the economic and financial prospects of a sector in the economy. The performance of a group of companies is analyzed simultaneously while assessing a single sector with the help of which an investor can efficiently judge how well the companies in a sector are expected to perform.

What is Sector Analysis?

Sector analysis is one of the best tools to recognize the performance of a group of companies in the stock market. For example, if an investor wants to invest in Kotak Bank, then analyzing the performance of the banking sector is essential. If the banking sector is performing well then the chances are high that Kotak Bank stocks will see an upward movement. The performance of a stock market sector can majorly influence the prices of companies working in that particular sector and vice versa. 

If a stock is strongly supported by the sector then it can perform well enough as sector support can push the prices to higher levels. Conversely, if the sector is not performing well then a very good stock might also drop down to below levels. Sector analysis gives useful insights about the present and future of various companies belonging to that sector in an economy.

Sector Vs Industry

Industry is a comparatively classified term than sector as it further categorizes businesses within each sector by common business practices and their area of focus. A sector can have a various number of industries within itself such as the energy sector might include energy equipment & services and oil, gas and consumable fuels as industry. On the other hand, the material sector includes industries such as chemicals, construction materials, containers and packaging, metals and mining and paper and forest products. The different sectors that are present in the Nifty includes Auto, Pharmaceuticals, Financial Services, Banking, Media, etc.

There are some stocks whose sector is not determined such as DMART which does not belong to any specific sector. In this case, market support is considered to analyze the future price action of the stock instead of focusing towards the sector support.

How does Sector Analysis Work?

In an economy, a sector cannot always remain at all time high or all time low levels. Sector rotation and top down approach are the two theories that have given a specified direction to the sector analysis framework. Let’s get to know about these theories by enlightening them.

Sector Rotation

Sector rotation is a powerful framework which states that a sector in an economy has to experience many phases from bottom to top or top to bottom. Investors use sector rotation as an investment strategy which is to shift the allocation of investments among different sectors. A business cycle is formed which determines the low and high phase of a sector. Sector Rotation theory can be understood thoroughly from the Trading In The Zone course offered by GTF. The concept of sector rotation revolves around the phases of economic cycles which comprises expansion, contraction, peak and trough. Each phase has a different impact over the sectors.

Expansion

It is a phase wherein a sector is expected to perform well in future and can reach at the top or the peak of the economic cycle. Investors consider that the bottom phase of the sector has ended and the prices of the stock belonging to that particular sector are expected to rise and reach an all time high. For example, the PSU bank sector is experiencing an expansion position currently where the stocks are at all time high prices and further surge in the prices is expected.

Peak

This phase represents the peak or the top phase of a sector. When a sector experiences an all time high situation then it is considered to be in its peak position. It determines that the stocks of a particular sector have provided multiplied returns to the shareholders. For instance, the Nifty Auto sector can be considered at its peak where the prices of the sector are at all time high.

Contraction

If a sector is in a contraction phase, it means that after experiencing the all time high situation, the investments are getting allocated to a different sector leading to a decline in the prices. This phase represents that the sector is moving towards the bottom phase of the economic cycle. The prices of stocks belonging to this sector will also experience a great fall in their prices.

Trough

A sector is in a trough phase when the majority of stocks of that particular sector experience all time low prices. Investors consider this phase as a buy at dip opportunity since a sector cannot be at its all time low lifetime. This phase is considered as a buying opportunity as it is expected that the prices will rise in future to complete the economic cycle. Once PSU Banking Sector was at its low in trough phase and now it’s at the peak of economic cycle. Currently, the Nifty media sector is at the trough position where the prices of media stocks are at the lowest points.

How does Sector Rotation work in Investing?

In investing, sector rotation refers to the process where a particular sector moves in a rotational direction, achieving all time high prices and all time low prices. During this process, investors consider a buying opportunity when the sector is at its lowest because buy at dip is one of the most efficient investing strategies. A sector that has all time low prices is set to achieve expansion and reach its all time high position. Investors buy the assets during the trough phase and hold till the asset price reaches its all time high position.

How does Sector Rotation work in Trading?

Sector rotation in trading is slightly different from that of investing because for traders the phase of the rotational cycle of the sector does not matter. Traders use the stocks for trading that are held for long term investment purposes. In these stocks, trades are executed when the prices of the stocks take a dip and come to a good demand zone. Once the short term target is achieved, these stocks are sold. This is how traders make benefits of sector rotation.

What is a Top-Down Approach?

Top-Down Approach in sector analysis is a part of investment strategy where investors analyze the stock from top down starting with macro economic factors and analyzing the sectors with securities. The Top Down approach provides a perspective to start investing by analyzing the sector, industry and the particular company.

Also Read: 20 Rules followed by Professional Traders

Conclusion

Sector Analysis is a much reliable investment strategy wherein the investors analyze the performance of companies based on the sector. Sector rotation and top down approach are the two main theories responsible for understanding the concept of sector analysis. The Trading In the Zone course offered by GTF briefly conducts sector analysis and helps investors to know each and every aspect of sector analysis.

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