Sharpen Your Edge: A Simple Guide To Sector Momentum Investing
This simple, but sophisticated trading strategy uses price momentum signals to keep you invested in the strongest US sectors – and shift you into bonds when markets get rough.
The S&P 500 has had an incredible run in recent years, mostly thanks to tech’s stellar performance. But holding onto it now comes with risks. Valuations are high, which could mean that future returns won’t be as sweet, and a shift in the economic outlook or the market mood could trigger a bitter bear market. Plus, with tech stocks making up such a big chunk of the index, your portfolio could be a lot more vulnerable if that sector stumbles.
In times like these, it could be smart to take a more dynamic approach – one that adapts to different market conditions, doesn’t lean too much on one sector, and helps manage your risks, without letting your emotions drive you.
Thesis
The Sector Momentum Edge is a simple, but sophisticated trading strategy. It uses price momentum signals to find the strongest US sectors and pivot to bonds when markets get rough.
This streamlined, rules-based strategy doesn’t require daily or weekly trades – perfect for investors who want an active approach without a ton of complexity.
The strategy has delivered an average annual return of over 11% since 2000, with a maximum drawdown of just 22%. Plus, it’s proved to be solid across different setups and time periods – no matter the tweaks.
Using this technique, a $10,000 investment in 2000 would have grown to $134,687 by October 2024 – more than double the $62,038 you’d have from investing in the S&P 500.
Risks
Turning points. The Sector Momentum Edge can lag during sharp market reversals, leaving you stuck in sectors that have lost momentum after a period of strength.
Choppy trading. In markets without clear trends, frequent reversals can lead to whipsaw effects, and small losses can add up because of mistimed trades.
Sharp dips. The strategy rebalances only monthly, so sudden market plunges can catch you off-guard, leading to significant losses before it can switch to safer assets.
Periods of underperformance. There will be years when the strategy doesn’t do nearly as well as the S&P 500, so you have to be prepared for that.
The strategy: The Sector Momentum Edge.
Sector momentum investing has two simple goals: riding high with the best-performing sectors and protecting your money when things get rocky. When a certain sector is performing well, that’s where you’ll invest. When stocks look shaky overall, you’ll shift into safer assets, like bonds.
See, stocks from different categories often react differently to things like economic growth, inflation, interest rates, and investor sentiment. Some thrive in certain conditions, while others struggle. In 2022, for instance, tech stocks lost around 30% because of rising interest rates and inflation, while energy stocks soared more than 60% in the same environment. On average, the difference between the best- and worst-performing sectors in any given year is about 40% – and in some years, it’s been over 100%.
So if you can spot the winners early, you can ride their wave and boost your returns. That way, you’re not just doing well in bull markets: you can be uncovering opportunities no matter how markets are faring.
To do this, you’ll use price momentum – the idea that what’s been going up will keep going up, at least for a while. More specifically, you’ll start with relative momentum, which compares the performance of different sectors to find the most robust among them. Research shows that the best-performing sectors often stay strong for months, which can give you an edge over spreading your bets across the whole market.
Granted, that’s hardly a perfect approach when everything is falling. In bear markets, picking the “least bad” sectors won’t cut it. So that’s when absolute momentum steps in. It’s not just about picking the best sectors – it’s about making sure they aren’t trending downward. When that’s not possible, you switch to bonds to keep your money safe.
This strategy is for folks who don’t want predictions or FOMO – just a set of rules that can reliably help them maximize returns and minimize losses. If that’s you, read on.
