When you think of day trading, “stock sectors” aren’t exactly the first thing to come to mind, right?
But if your goal is to be a killer trader, then you must understand the different stock sectors and why they matter. It’s important and you need to know it.
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So let’s do this. Here’s what stock sectors are, the 11 different stock sectors, and how to use them to your advantage.
Table of Contents
- 1 What Is a Stock Sector?
- 2 The Different Stock Sectors
- 3 How To Access Different Stock Sectors
- 4 Importance of Diversifying Your Investments
- 5 The Bottom Line
What Is a Stock Sector?
There are thousands of companies in the stock market.
Each stock is placed in a “sector.” This means that each stock you invest in fits into a specified sector. These sectors are generally representative of the overall sectors of the economy.
(If the word sector doesn’t appeal to you, you can just think of them as “categories.”)
Understanding the sectors and why they’re important for stock trading can potentially give you an edge in the market.
So let’s look at all the sectors now …
The Different Stock Sectors
According to Global Industry Classification Standard, there are 11 different stock sectors. Here’s a look at each sector, along with some of the largest and well-known companies in each.
The energy sector contains oil, gas, coal, and fuel companies, as well as energy equipment and services. You can think of the equipment and services as the companies that build oil-drilling equipment, and the services as companies that oil companies hire.
Your major players in this sector are Exxon, Shell, Chevron, BP, Kinder Morgan, Schlumberger, and Halliburton. These companies generate billions of dollars in profit every quarter and have generous dividends.
This sector is strongly correlated with the price of crude oil. If the price of crude oil is falling, you can bet that the companies in this sector are falling as well. However, the stock prices of these companies are relatively stable, and the generous dividends can make them a good long-term hold. They can also be a good choice if you’re looking to get defensive in a rough market.
The basic materials sector are chemical, construction materials, packaging, metals, and paper companies.
These companies are usually operating in the business-to-business space, meaning that they sell their products to other companies. They provide the key supplies that are put into the products that you and I purchase.
You can think of these companies as being at the beginning of the supply chain. They provide the steel for cars, the wood for homes, the plastics for packaging, and much more.
The most well-known companies in the materials sector are DowDuPont, Ecolab, Valvoline, Scotts Miracle-Gro, and Sherwin-Williams.
Next up is the industrials sector. The defense, machinery, aerospace, airlines, construction, and manufacturing companies are in this sector.
There are a lot of large-cap companies in this sector. They include Boeing, 3M, Honeywell, UPS, Delta, Lockheed Martin, Deere, Caterpillar, and many more.
Much like the oil companies, these industrials generate lots of cash flow and have stable dividends. If the defense budgets for countries around the world are increasing, you can bet that more cash will be flowing to the defense companies in this sector.
The fourth sector on our list is consumer discretionary. These are companies where you and I spend a lot of our money. It’s where our discretionary income goes. It’s the retailers, apparel, restaurants, autos, hotels, media, and household products.
You’ve heard of the companies in this sector. It’s where Amazon, Home Depot, Ford, Wynn, Starbucks, Target, and Chipotle are. We shop, eat, and travel with these companies.
When consumer confidence is high and people are spending their money like no end, these companies are making bank and they’ll probably have strong quarterly earnings.
Along with discretionary, there’s also consumer staples. These are the food, beverage, and tobacco companies. They’re also manufacturers of household goods and personal products, as well as supermarkets.
You’ve likely heard of many of the companies in this sector because they sell products to you. They include Walmart, Coca-Cola, Procter and Gamble, Costco, Kraft Heinz, Estée Lauder, and many more.
This is considered a defensive sector because these companies are generally resilient in the event of an economic downturn.
The difference between consumer staples and consumer discretionary is that the staples are companies that produce products that people buy on a regular basis. They also include supermarkets like Walmart. Discretionary are products that people don’t need to purchase.
People don’t need to buy new cars, clothes, or eat at restaurants. But they need to buy food and household goods — and they’ll likely buy it from supermarkets.
Companies in the healthcare sector are the pharmaceuticals, healthcare equipment, and healthcare services.
Johnson and Johnson, Pfizer, Merck, Medtronic, and UnitedHealth are some of the bigger companies in this sector.
The companies in this sector are often good plays and safe bets because people will always need medical care, whether it’s from pharmaceutical drugs or hospital visits.
The financial sector consists of banks, insurance, and real estate companies.
This sector is closely tied with interest rates. If interest rates increase, then big banks make billions of dollars more. This is because banks give out loans and mortgages, and the higher interest rates all go to the banks.
JPMorgan, Bank of America, Wells Fargo, U.S. Bank, Goldman Sachs, and many regional banks are in this sector.
Commonly referred to as the “tech sector,” companies in this sector include internet, software, and semiconductor companies. Also included are companies that manufacture electronic equipment, data processing, communication equipment, and IT services.
Microsoft, Intel, Visa, MasterCard, Adobe, Salesforce, and Square are some of the largest companies in the tech sector.
The tech sector is one of the leading sectors of the last few years. This means that if the bull market continues to run, we’ll need strong earnings from companies in the tech sector.
This sector is companies in the communication services. You know them as Verizon, AT&T, T-Mobile, Sprint, Comcast, Charter, Netflix, Facebook, and Google.
Most of the companies in this sector rely heavily on recurring revenue, while some others earn the bulk of their revenue from advertising revenue (think Facebook and Google).
These companies are your electric, gas, and water utilities. They have little to no competition in the areas they operate, and local governments regulate most of their prices.
Since these companies operate in regional areas (i.e. there isn’t one national electric or water provider in the United States) you would likely only recognize your local utility. Some of those utilities are Duke Energy, NextEra, PG&E, Xcel, and NRG.
These are considered defensive sectors because people will always need what these companies sell. Like most sectors, they’re subject to heavy government regulation, but they’re safe bets in a shaky market environment.
This last one is pretty self-explanatory. It’s real estate companies called REITs (real estate investment trust) and real estate developers.
They operate apartments, malls, offices, and senior living communities. If your grandma is in a nursing home, chances are the company operating that community is publicly traded in the real estate sector.
Companies in this sector earn their revenue from rent income and increasing property values. And since they pay out at least 90% of their taxable profit as a dividend to shareholders, they’re usually great for a long-term hold, with dividend checks coming every three months.
One prominent company in this sector is Simon Property Group, which operates malls. AvalonBay Communities and Aimco are some of the larger apartment operators.
How To Access Different Stock Sectors
To access and trade the different stock sectors, you need to have a brokerage account.
You can trade each individual sector by trading an exchange-traded fund (ETF).
Think of ETFs as being a group of stocks all placed into one fund. And you can buy that fund which has that group of stocks. These ETFs are less volatile, which can make them great for beginner traders that can become scared off by rapid (and sometimes extreme) price movements.
There’s a group of ETFs called the SPDR. A company called State Street Global Advisors manages these ETFs. The SPDR ETFs are very popular, and in the SPDR group, there’s an ETF for each sector.
Here’s a list of each sector and the corresponding SPDR ETF:
- Energy – XLE
- Basic Materials – XLB
- Industrials – XLI
- Consumer Discretionary – XLY
- Consumer Staples – XLP
- Healthcare – XLV
- Financial – XLF
- Information Technology – XLK
- Communications – XTL
- Utilities – XLU
- Real Estate – XLRE
You can use your brokerage to invest and trade these ETFs. Since an outside company manages these ETFs, they have fees with them in the form of an expense ratio. This charges shareholders a percentage (usually less than 1%) of the funds total assets. That money goes toward administrative, management, advertising, and some other expenses.
In addition to ETFs, you can also invest and trade individual stocks that are in a sector. For example: If you bought stock in Ford, you’re buying a stock in the consumer discretionary segment.
Key Different Stock Sectors in the European, Asian, and Canadian Stock Markets
The European, Asian, and Canadian stock markets have the same sectors as the United States stock market. This similarity gives investors the opportunity to compare stock sectors across countries.
You can check how the sectors in other countries are performing by going to Bloomberg and clicking on each continent to see how the sectors are performing in that region.
Importance of Diversifying Your Investments
You know the saying, “don’t put all your eggs in one basket?”
That’s especially relevant to the stock market.
Why? Because stocks in the same sector tend to move together. This means that if some energy stocks are down, chances are other ones will be as well. This is why you need to diversify your investments and make sure you’re spread into different sectors and increasing your exposure to some more defensive sectors.
This is precisely why understanding stock sectors is so important! Take a look at this list that shows how each sector has performed over the last year:
As you can see, some sectors are performing really well while others are lagging. To help you understand why tracking different stock sectors performance is important, let me give you an example.
Let’s say late last year you decided to invest in five stocks and hold them for the duration of 2018. And for all five stocks you chose bank stocks because you hypothesized that they would have a good year.
As you can see, that strategy would turn out very poorly. Financials are one of the worst-performing sectors this year. Instead, if you picked stocks that are in separate sectors (i.e. diversifying your investments) then you would have fared better.
You could have invested in a real estate stock, tech stock, energy stock, and consumer discretionary in addition to your financial stock. This would be a more balanced portfolio with exposure to different areas of the market.
See? Don’t put all your eggs in one basket!
Prepare Yourself to Invest in Different Stock Sectors
Before you start diving in and picking your favorite sectors to invest in, you first need to gain an understanding of each sector.
To do that, you can first take a bird’s-eye view with the yearly performance of each sector, and then narrow to the monthly performance, and then daily performance. You can check the daily S&P performance of different stock sectors on CNBC.
If you’re looking for a longer-term investment, you’ll want to keep an eye on how the sector has performed over the last year. For instance, the financial stocks haven’t performed very well the last year. So if you were looking for a long-term hold, why would you add a financial ETF or a bank stock?
Granted, past performance isn’t indicative of future results, but — the trend is your friend. If the trend is down, you probably don’t want to be buying and hoping it turns around. In the stock market, hope won’t get you very far.
If you’re just looking to day trade or swing trade, then monthly or daily performance overviews will be useful. Find the sectors that are performing well today, and then look at some of the strongest stocks in that sector. Pull up the charts and do some technical and fundamental analysis.
Keep in mind that just because a sector is having one strong day, that doesn’t guarantee it will last any further than that day. For example, if the price of crude oil increases, then a stock like Exxon (XOM) will increase as well. But crude is subject to many catalysts, which means that it can swing and decline quickly, and Exxon’s stock will too.
Just like any good trader, be sure to time your entries and exits well, and cut losses quickly.
Ninety percent of traders fail because they enter trades without any plan.
They buy a stock because they like the company or because their friend told them to buy it. Then once they’re in the trade, their only plan is to hope the stock price increases. Remember what I mentioned earlier? I’ll say it again: Hope is not a strategy.
When it comes to trading, hope straight-up sucks. You will fail with this “plan” and all the hopes and dreams you had of becoming the next millionaire day trader will soon be gone — along with your money.
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The Bottom Line
Stock sectors might not be the most exciting facet of your trading education, but it’s crucially important if you want to be a part of this world.
If you plan to put your hard-earned money into a stock, then you better know how its sector has performed. Coming in blind without any knowledge of the way it operates in can be a recipe for disaster. And that, my friend, is why sectors matter.
Here’s a better strategy:
- Start by getting yourself familiar with how the different stock sectors performed over the last year.
- Then begin your trading day by checking to see how the different stock sectors are performing for the day.
- Understand why they’re moving in their current direction.
- Then start hunting for some stocks you’d like to go long or short on.
Got it? Good. Doing this can get you off to a better start as a trader because you’ll know which stocks have momentum behind them and which have some headwinds.
What sectors do you have a tendency to trade? Why? Share your comments below.