Sector analysis is an investment assessment technique in which investors group companies that perform similar functions within the economy into sectors when analyzing potential stocks. The idea behind this mode of thinking is that stocks within a certain business type will tend to rise and fall along with the performance of the sector. Investors may break the sectors down into general groups such as transportation or technology, or into more specific categories to better pinpoint potentially hot stocks. There are several strategies that investors can use once they've analyzed the sectors to try and improve their investment performance.
With a seemingly limitless amount of stocks available to investors, it can be daunting for them to go through them all, amass information, and track the performance of individual stocks. Investors can use sector analysis to help narrow down the field of possible investments by simply concentrating on large groups of companies that are similar to one another in terms of the role they play in the economy. The theory behind this strategy is that the stocks within these groups tend to act in accordance with all the others.
For example, if the technology sector is performing well, then an investor can conceivably choose any company within the technology sector and get a positive result. The larger sector groupings include technology, energy, consumer services, health care, finance, and industrial. From these larger groups, smaller groups within can be targeted if the investor chooses to do so. If, for example, the auto industry is outperforming the rest of the larger transportation sector, then investors may want to focus on the companies within that industry instead of other transportation companies.
Using sector analysis allows an investor to take part in any one of several different investment strategies. An investor wishing to diversify a portfolio can use the tendencies of the different sectors to achieve this. Some sectors, such as the technology, tend to rise and fall with the market, but there other less volatile stocks that tend to avoid market highs and lows. Taking stocks from steadier sectors can provide a nice bedrock in a portfolio, allowing an investor to take a chance on some riskier sectors for a possible high return.
Another possible strategy is top-down investing, in which an investor identifies the sectors performing the best and chooses stocks from within, then moves down to a sector not performing quite as well, and so on. The sector-rotation strategy is another popular offshoot of sector analysis. In this approach, investors count on the cyclical nature of the market and try to guess which sectors are due for a surge. As other investors do the same, that sector will go even higher until it peaks. At that point, the investor rotates sectors and invests in the next one which he or she feels is headed to the top.