How to Choose a Sector for Your Very First Trade
I’ll be right up front from the beginning.
If you’ve known me for a while, you already know that I don’t trade market sectors, but a specific type of stocks called penny stocks.
But if you understand well how investment sectors function, you can have an advantage over investors who just bet on the direction of the market without having the most minimal structure from which to analyze investment opportunities.
Fortunately, investment sectors are here to provide part of that structure. They can help you understand how the stock market is organized, how groups of similar companies perform, and how they move and react to news, events, and the economy.
That information is useful to help you spot potentially good investment opportunities that can grow your investment account. In other words, keep reading this post.
Here, I’ll give you a high-level view of what these investment sectors are, their characteristics, and more important, how you can use this knowledge to your advantage.
Sectors are a big deal, and you need to know about them.
So stay with me for a few minutes and let’s take a look at this topic. Some of it’s kind of dry, but just absorb it and let’s keep moving.
What Are Investment Sectors?
Investment sectors are major categories of publicly-traded companies grouped together based on their main business activity. They are also known as industries because they represent companies in a similar or related type of business activity.
For example, companies like Apple and Microsoft belong to the technology sector, while companies like Exxon Mobil and Chevron fall under the energy sector.
But, why would the market want to group companies this way? Well, it makes the analysis of the market far easier.
As companies in the same sector tend to perform the same way and conduct businesses with similar risks, they can be analyzed and compared in the same terms.
So, to provide a structure to categorize the market, a couple of global companies — MSCI and FTSE Russell — have come up with classification systems to organize the market in major categories or sectors.
GICS classifies the stock market in 11 sectors, 24 industry groups, 68 industries, and 157 sub-industries. Each company is assigned a single GICS classification according to its principal business activity.
After companies are classified into sectors, investors can visualize the market as in categories. You can see the different corners of the market and how they relate one to each other.
Note there’s a universe of around 3,500 exchange-listed companies in the U.S. Plus, there are more than 10,000 that trade in the OTC market. That’s a big number to analyze.
Do you see now see why the market needs to have at least some basic structure? I think you’d agree.
How to Find Opportunities
Every time I’m asked how to find great market opportunities, I never get tired of answering the same way over and over again.
To identify attractive stocks, sectors or markets to invest in, you’ll need to do some homework.
Let’s take a look at the two main methods used to analyze the market and its different corners and segments (e.g. market structure): technical analysis and fundamental analysis.
For now, I want to give you a good overview so you can start your research in the right place.
As you probably know, this is the study of stocks, sectors, or index chart prices over a period of time. Charts are important because they capture the full price and volatility history of a stock.
And, although the past doesn’t guarantee future performance, under certain patterns I teach, they can be helpful in analyzing what might transpire in the future.
This the study of a company’s financial information, such as earnings, growth rate, financial position, and economy.
From this analysis, you can figure out if a business is sound or unstable. You can get an idea of the value of a business, understand its potential, and determine if it could be a good fit for you.
How can you use these analyses to help you find sectors?
One way is through trend analysis. You could analyze the historical trend of a sector using charts and get an idea of its future’s performance.
Another possibility is called relative strength analysis. This is when you compare the performance of all sectors in one chart, identifying which ones look stronger or weaker with respect to others. It helps you choose some sectors over others based on their relative strength.
These two methods are part of technical analysis, but there’s another option more related to fundamental analysis that I want to share with you…
Much of the value of a company lies in its ability to generate earnings. If you can estimate earnings with a good degree of certainty, you could get a good idea about the future price of a stock.
And if you do this for the main stocks in a sector, you can potentially get a glimpse of the performance of a sector.
This is the game Wall Street security analysts play. Investment banks usually issue recommendations (ratings) to buy, hold, or sell companies based on their earnings. They also issue sector reviews based on their future potential outlook.
In any case, no matter what method you use to evaluate sectors, know this:
The market places a huge value on companies’ earnings because earnings can heavily impact stock prices, often causing volatility and spiking.
So let’s expand more over a certain period of the year that brings enormous opportunities to profit from the market.
Tomorrow, I’ll welcome you to earnings season…
Editor, Penny Stock Millionaires