Sector Rotation Strategy
Which Indicators can we use to trade using Sector Rotation?
In this section, let us now discuss some specific strategies which can be followed by a trader to identify and differentiate the strong outperforming sectors and the weak underperforming sectors.
1.Relative Strength (RS) Indicator –
“Relative Strength is a ratio between two assets, most often a stock and a market average (index). To calculate the relative strength of a particular stock, we can divide the percentage change over a time period by the percentage change of a particular index over the same time period". This indicator oscillates around zero. If the value is greater than zero, the stock has been relatively strong during the selected period; if the value is less than zero, the stock has been relatively weak.”
It can also be used to find stocks that are holding up better during a broad market decline or showing weakness during a broad market advance.
We can create template charts with RS indicators for the sector index to determine the leaders and the laggards. Once the leading sectors have been determined, we can then look within these sectors to find the leading stocks. Sectors that show relative weakness can be avoided to help narrow the search. One thing to note is that the RS works better on cyclical sectors, or stocks that are very volatile in nature.
2.Relative Strength Index (RSI) –
Relative Strength Indicator or RSI is a momentum indicator which identifies stocks that are overbought or oversold in relation to their prices. The RSI oscillates between zero and 100. Traditionally, the RSI is considered overbought when above 70 and oversold when below 30. Signals can be generated by looking for divergences and failure swings. RSI can also be used to identify the general trend.
Note: Both the Relative Strength Indicator and the Relative Strength Index are different.