Investment Tips: What Is Sector Analysis And What Is It Used For?

An introduction to sector analysis, with how it works and what it is used for.

There are three things that will affect the performance of a company's stock. The first is the performance of the individual company. The second is the performance of the market as a whole. The third is the performance of the company's sector.

Just as an individual company's stock tends to rise and fall with the market as a whole, a company's stock will also tend to rise and fall with its sector.

Sectors are groups of companies that perform similar functions within the economy. Sector analysis involves dividing the overall market into sectors and then studying the performance of each sector individually, so that sectors can be compared to each other or to the market as a whole.

Different analysts use different breakdowns of sectors, but a typical sector list would include consumer staples, consumer services, energy, financials, health care, industrials, technology, transportation, and utilities.

Investors can use sector analysis in three ways: to guide diversification, to find sectors with above-average performance, and to time the market.

Some sectors are more volatile than others, reacting more strongly to changes in the overall economy. For example, the technology sector tends to do well when the overall market is rising, and poorly when the overall market is falling. Consumer staples, on the other hand, are more stable, neither rising as much as technology during strong markets, nor falling as much during weak markets.

To use sector analysis to guide diversification, select stocks in both volatile and stable sectors. That way, when the economy is strong, you will benefit from the growth in the volatile sectors, and when the economy is weak, stocks in the more stable sectors will provide a cushion.

A more risky strategy is to concentrate investments in sectors that are currently outperforming the market. This is a form of momentum investing. The idea here is that sectors that are outperforming the market will attract more investors, which in turn will cause the price of the stocks in that sector to continue to rise.

A third strategy is a market timing strategy which is in some ways the opposite of momentum investing. Market timers look for trends within a sector. The idea is that sector performance is cyclical, and the rise and fall of a sector can be charted. Market timers try to sell their sector stocks just before the sector peaks, and buy their sector stocks just before the sector troughs.

The online financial sites are good sources of information on sector performance. You can find news and statistics for each sector, lists of the best-performing stocks within each sector, and charts that compare the performance of sectors to each other. Each sector may also be broken down into subgroups of industries. For example, the financials sector may be subdivided into consumer financial services, insurance, investment services, savings and loans, and banks. Statistical and other information is available for each of the subgroups, so you can fine-tune your research.

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