Choosing a Stock Sector for Your Very First Trade

Choosing-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, stock 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?

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Analyzing data. Close-up of young businessman looking at the data presented in the chart while working. Via shutterstock.com

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 stock 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.

Here, I’ll talk most about the Global Industry Classification Standard (GICS®) created by MSCI, though the Industry Classification Benchmark (ICB) from FTSE Russell would do the work as well.

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

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Close-up of businessman with digital tablet created by Pressfoto – Freepik.com

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, stock 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.

I give much more detail about them here, but for now, I want to give you a good overview so you can start your research in the right place.

Technical Analysis

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.

Fundamental Analysis

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 stock 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 stock 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 stock sector reviews based on their future potential outlook.

In any case, no matter what method you use to evaluate stock sectors, know this:

The market places huge value on companies’ earnings because earnings can heavily impact stock prices, often causing volatility and spiking.

That’s important. So let’s expand more over a certain period of the year that brings enormous opportunities to profit from the market. Welcome to earnings season …

The Earnings Season

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Earnings Season ID: 785642830 created by kram9 – Shutterstock.com

As you might now, all publicly-traded companies are regulated to disclose their financial information, including earnings, every quarter.

After the first three quarters of the fiscal year, they have to file the 10-Q report, a partial report on their financial performance and operations. After the fourth quarter or after their fiscal year-end, they have to file the 10-K report or annual report.

Because most companies are required to file within 45 days of the fiscal quarter-end, and most companies follow the calendar year schedule, you’ll see a lot companies reporting their earnings in the same period.

This period is called the earning season.

Why is this important? Because this period can create a huge opportunity for investors and traders to take advantage of significant stock runs that occur as a result of these earnings releases.

As stock prices reflect investors’ expectation about their earnings, and companies can beat, meet, or miss analysts’ earning expectations, you’ll see a lot of stocks moving, high volatility, and better opportunities to trade during that period.

I wrote a much more detailed post about this, and you can read it here. But the bottom line is that you must pay attention closely to this period. You don’t want to miss the many opportunities available to potentially grow your account.

Examples of Top Sectors to Invest In

The GSCI methodology counts 11 stock sectors in total.

They include energy, materials, industrial, consumer discretionary, consumer staples, health care, financials, information technology, telecommunication, utilities and real estate.

To learn more details about each stock sector, you can check the MSCI website. Each sector has its own index to track its performance. That’s one way investors have to follow how a sector is performing.

Let’s take a look at five of the most important stock sectors of the market.

Information Technology

This stock sector comprises companies selling software, hardware, semiconductors and/or technology-related services like Microsoft, Apple, Intel, or Cisco.

Companies is this sector have driven market growth over the last several years. This is the biggest stock sector by market capitalization and represents close to 25 percent of the total market.

Some technology companies, like Alphabet (GOOGL) and Facebook (FB), used to belong to this sector, but they have been now reclassified to the newly expanded communication services sector, which now replaces the old telecommunication stock sector.

Companies in this sector with innovative business models — or “the next breakthrough idea” — are all the rage, so many investors and traders follow companies here.

Consumer Discretionary

This sector includes companies that sell products or services that are considered non-essential or discretionary by consumers.

When the economy goes well, this stock sector tend to perform much better because consumers have that “extra” money to spend on non-essential items.

Companies like hotels and casinos, restaurants, education services, media and entertainment companies, apparel, and big-box and internet retail stores are part of this stock sector.

Big names like McDonald’s, Nike, Starbucks, and Amazon are classified as consumer discretionary companies. When you think of spending money “out-of-home” in leisure or retail, this is the category to think of.

As many people shift their spending habits to enjoy “experiences,” analysts expect a huge influx of money coming into this stock sector, so monitor the market to spot interesting investment opportunities.

Financial Sector

This stock sector includes major financial groups, banks, insurance companies, investment banking firms, and brokerage companies, among similar outfits.

Citigroup, Goldman Sachs, Bank of America, and American Express are a few of the big names in this sector.

As the government rolls back costly compliance regulations that used to apply to small and regional banks and financial firms, there good opportunities to explore here.

Real Estate

Investing in “bricks” has always been a part of the strategy of many successful investors, either by investing in properties themselves or through vehicles like real estate investment trusts (REIT).

A REIT is basically a company that buys and operates income-producing properties like shopping malls, office or apartment buildings, hospitals, and warehouses.

They’re excellent income-producing investments because, by law, they need to distribute at least 90 percent of their taxable income to investors via dividends. As with any investment in real estate, the best opportunities are found on undervalued companies that generate free cash flow.

Energy

When you think about energy stocks, the first thing that comes to your mind is likely oil.

While there’s a lot of market expectation about alternative energy, the truth is that the bulk of the market still lies in traditional oil and gas companies.

This type of stock tends to do better during times when oil price rise and stay high, and then pull back during times of falling oil prices.

That’s five of the 11 sectors, but you get where this is headed. Let’s move on to trading. You can check out the other sectors here and here.

How to Choose a Stock Sector for Your Very First Trade

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Depending on what type of investor or trader you are, choosing a stock sector or a strategy to focus on can be a great start.

Passive investors who play the long game usually choose a specific stock sector to invest in through mutual funds, ETFs or specific stocks they know well in the sector.

On the other hand, active traders don’t necessary focus on a sector, but rather on a corner of the market with plenty of opportunities to trade — potentially with the odds in your favor.

Whatever the case, let’s review a couple of stock sectors of the market that frequently have something to offer …

Technology Sector Performance

Technology dominates a big part of our lives, so companies in this stock sector have led the growth over the past decade. Many of the most recent success stories are technology companies. Can you think of any?

Also, because the market is always trying to find the next “big thing,” companies in this stock sector are on the spot for many investors, bringing volatility and offering trading opportunities for long-term investors and traders alike.

S&P 500 Sector Performance

Though the S&P 500 isn’t really a stock sector, the index tracks the biggest 500 companies in the U.S. market, so it also deserves a bit of our attention.

As the index represents around 80 percent of total market capitalization, its performance influences the rest of smaller stocks in the market and investors’ market sentiment. It marks a trend you want to be aware of.

A well-known, long-term passive investment strategy is “buying the index” through a fund or ETF that tracks the market. As I said, the S&P 500 has returned 9.5 percent per year over the last 10 years.

Though I focus on trading smaller stocks, penny stocks specifically, I still recommend you get to know and follow the S&P 500 index. It can help you to understand the overall market sentiment at any given time.

Best Sectors to Invest in Long Term

When people ask me about the best long-term sectors and companies, I always answer the same: There’s not an exact way to predict the long-term future and know exactly the best option.

But there’s one thing I know for sure: To become a stock sector-type investor with potential, you’ll need to develop a deep, expert knowledge of the economy, fundamental analysis, and the sector’s business cycle.

That’s a specialized, complex skill to master … but I like to keep things much more simple.

Key Tips on Choosing Sectors to Invest In

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© 2018 Millionaire Media, LLC

The key to choosing a good stock sector or a good stock is doing lot of research and studying the market as much as you can until your eyes get blurry. There are no shortcuts.

But because I know that many people are going to ask me again anyway, I have a few tips so you can start doing your homework in the right place. But remember, there isn’t a magic formula for this.

Technical and Fundamental Analysis of the Stock Market

As I mentioned earlier, there are two main analysis approaches you’ve gotta understand and get the pulse of the stock market.

Technical analysis is based on the study of stocks’ chart prices and patterns. Knowing how to read stock charts is critical because charts capture the full history of a stock’s past performance.

As part of the application process to my Trading Challenge, I have a free master class where I explain some of the fundamentals of technical analysis and provide some examples that show how I’ve gotten ahead using this trading approach.

Then we have fundamental analysis. You don’t need to be an expert on this, but it doesn’t hurt to know how to read financial information, earnings, and estimates.

Knowing these two approaches is undoubtedly helpful. It can help filter out the noise and get to the real gems. That’s what finding opportunities is all about.

Liquidity, Volume and Price

Liquidity, volume, and price are three critical variables related to technical analysis that every trader or investor must know. If you’re an active trader, this is even more important.

These three qualities can tell you a lot about a stock and act as a filter criteria to help spot opportunities.

Liquidity is the number of shares of a particular stock that are traded on a regular basis. High liquidity allows you to enter and exit a position in the market relatively easily. There’s no point in trading a stock with no liquidity. It’s too risky.

Regarding volume, an increase in volume means something’s going on. There’s probably breaking news, an event, or something that results in the stock’s price movement.

Lastly, stock price is another key variable you need to understand well. There are several reasons. In my case, I trade mostly penny stocks, which cost less than $5 per share.

A low price is important because that means you don’t need a huge investment account to potentially capture significant profits.

Be Careful While Choosing What To invest In

I’ll never stop saying this: Don’t waste your time in this game unless you have dedication, focus, and you’re cool with research — those are the traits I want in my students.

Besides learning technical and fundamental analys,s, you also need to be aware of the risk and have a way to manage it.

Risk Control and Mind Stops

When you enter a position, you’ll never be 100 percent right every time. Sometimes, you’ll be wrong no matter how rational your analysis was.

When this happens, you need to be prepared in advance to manage this situation. The best way is to have a plan to exit the position with a small loss.

If a position goes in the wrong direction, you need to be willing to exit the position and take a modest loss before it get bigger.

Don’t crush your account … don’t crush your confidence … just get the hell out.

Master your Skills with a Mentor

You did it! You learned stock sector basics. See, that wasn’t so bad.

When I learned this stuff, I took the long way. I had to learn everything on my own with hard work until proving myself successful. I didn’t have a mentor or someone on my side willing to guide me.

And that’s risky. I made it, but for many aspiring traders and investors without much of a background in this stuff, their losing streaks are longer than the size of their bank account, and that’s the end of it.

Long story short: Get a mentor.

Trading Challenge

If you’re interested in learning from people — me as well as my top students — consider joining my Trading Challenge. It’s the ultimate way to communicate with other investors, get tips, share your plays, and learn from others’ successes and failures.

You’ll get access to tons of resources, including my every trade, so you can learn how to make trades for yourself. It’s also a great way to hold yourself accountable to your goals and to keep your ego in check.

When you go it alone, you risk making small but critical mistakes that deplete your profits.

Join us today and start learning from the experts. You won’t find promoters or other scam artists. It’s just a community of people who want to change their lives with the stock market.

The Bottom Line

Knowing about investment sectors can give you a good foundation to understand how the market works, how groups of similar stocks behave and react, and how investors perceive them.

Know that you know it, use it as a starting point to help you monitor, spot, and take advantage of the opportunities the market offers you.

Do you prefer one market sector in particular? Why? Chime in with a comment below.

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