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Faber's Sector Rotation Trading Strategy

ChartSchool describes a strategy, Faber's Sector Rotation Trading Strategy, to select the best sectors on given timeframes be it 1 month, 3 months, 6 months …. My question becomes, assuming the strategy works for selecting a sector would the same, or similar, strategy work for picking industries within the sectors followed by stocks within the industries. My approach would be something like, for the first 3 months pick 3 stocks each month until I have 9 stocks. In the 4th month and each month thereafter pick 3 new stocks to replace the 3 oldest stocks.

Seems simple enough using performance with the three-month Rate-of-Change as the selection method along with some other metrics suggested by the article.

Anyone tried this or something similar and if so, was it successful?


  • markdmarkd mod
    edited September 2019
    Well, the short answer is, I don't know.

    It seems whether to use a sector rotation strategy depends on your goals. If you are investing for the long term, and you want the protection of diversification, and have limited time for the market, it probably makes sense.

    If, as it seems, you want to improve performance, your approach might make sense, but it will take more time and there are things to keep in mind.

    First, as you seek performance, you have to be willing to sacrifice some safety. Fewer stocks means fewer chances you will have gainers to balance your losers if you pick wrong.

    Second, the indexes are capitalization-weighted. That means the biggest cap stocks in an industry determine what the index for that industry does. That can obscure the performance of mid and small cap stocks, which might be doing much better (or worse). So, if you go looking for the best ROC stocks only in the best ROC industries, you could be missing good stocks overshadowed by their poorer performing big cap siblings.

    Third, the "best ROC" method is essentially a breakout strategy. You assume that a trend in place will remain in place. Of course this is what happens with big winner stocks, but big winners are the exception, not the rule. You don't know ahead of time which breakout stock is going to continue on. If you adopt a sector strategy, you don't have to pick the winning stocks. The sector strategy is intended to capture longer term economic trends without choosing which specific companies will benefit most. Most stocks do NOT trend for very long. So a best ROC strategy could get you in at peaks.

    Another strategy is mean reversion. Buy the shorter term declines within a longer term uptrend. So, you might look for stocks trading above a rising long term (200, 251) moving average, but in the lower range of a short term (21) stochastic. And to narrow the choices, you might look for $SYMBOL:$INDUSTRY RS to be above a mid-term (50, 63) rising moving average. And you would discard any symbols showing recent heavy selling, especially volume off the top, or high volume, wide range up bars closing down, or with small bodies near the bottom of the bar (blow-offs).

    Still another strategy is emerging trends, or bottom picking. This is a discretionary approach, where you have to read the chart, not a formula approach you can capture with indicators. After a stock has really sold out, there is little to keep it from rising because the sellers are gone, and since prices are low, percentage gains can be big. But it takes careful shopping. The downtrend momentum should be broken (at least the mid term MA is flattening out). There should be evidence of strong buying - at least a few long body up candles with above average volume, or a string of 6 or more consecutive up bars. But prices should be ranging sideways over at least several weeks as this buying happens Also, look for strong selling that doesn't make significant new lows (either a long down bar that doesn't break support, or a very compressed bar near the lows). Then look for the mid term average turning up under a falling long term average, and showing good $SYMBOL:$INDUSTRY RS.

    So, maximizing performance means spending more time on the market to find potential big winners. The more you want to maximize performance, the more time you have to spend at it. If you don't have that time, a broader, more diversified formula-type makes sense.

  • Nicely said
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