Sector rotation for swing traders
Rank sectors by relative strength over two lookback periods and use the ranking to focus your swing-trading scans.
What you will learn
- How to build a relative-strength line between a sector and a benchmark
- How to rank sectors with two lookback periods and an average rank
- How to turn a sector ranking into a short list for stock scans
- Why sector leadership can change quickly and how to limit that risk
Explanation
Sector classification and the link between sectors and the business cycle are covered in the course Sector & Industry Analysis. Relative strength as a scan filter for single shares was covered earlier in this course. Here you apply relative strength to whole sectors, so that you scan first where demand is strongest.
Sector rotation
Sector rotation describes money moving from one group of industries to another over time. For a swing trader it is not a forecast of the economy. It is a practical filter: shares in a sector that is outperforming the market tend to have more buyers on pullbacks, while shares in weak sectors face more sellers on rallies. This is a historical tendency, not a rule that holds in every period.
The relative-strength line
The relative-strength (RS) line divides the sector price by the benchmark price on each date:
RS = sector price ÷ benchmark price
A rising RS line means the sector is doing better than the benchmark, even if both fall. You can use a sector index or a sector exchange-traded fund (ETF) as the sector price, and a broad index as the benchmark. Use the same currency for both.
The change in the RS line over a period is:
RS change = (1 + sector return) ÷ (1 + benchmark return) − 1
A simpler version is the return difference: sector return minus benchmark return. Both give the same ranking in almost all practical cases.
Two lookbacks and an average rank
A single period can mislead. A practical method uses a medium lookback of about 13 weeks (one quarter) to show established leadership and a short lookback of about 4 weeks to show recent change. Rank the sectors in each period, then average the two ranks. A sector strong on both is a leader; strong on 13 weeks but weak on 4 weeks may be fading; weak on 13 weeks but strong on 4 weeks may be turning up.
Rules of thumb
- Update the ranking once a week, for example at the weekend, not every day.
- Scan for long setups mainly in the top two or three sectors; avoid new longs in the bottom two.
- Do not switch sectors just because a rank changes by one place; require a clear change on both lookbacks.
- Leadership can reverse after news, rate changes or earnings; the stop on each trade still controls the risk.
Worked example
Hypothetical example: four sector indices A to D and a benchmark index. All values are invented round numbers. Costs are excluded because no trade is made yet.
| Sector | 13-week start | 13-week end | 13-week return | Minus benchmark (+4.0%) | 4-week return minus benchmark (+1.5%) |
|---|---|---|---|---|---|
| A | 50.0 | 55.0 | +10.0% | +6.0 | +1.0% − 1.5% = −0.5 |
| B | 80.0 | 82.0 | +2.5% | −1.5 | +3.0% − 1.5% = +1.5 |
| C | 120.0 | 114.0 | −5.0% | −9.0 | −2.0% − 1.5% = −3.5 |
| D | 30.0 | 32.4 | +8.0% | +4.0 | +4.5% − 1.5% = +3.0 |
- Benchmark 13-week return: from 400 to 416 = 16 ÷ 400 = +4.0%.
- RS change for A: 1.10 ÷ 1.04 − 1 = +5.77%. Check with the RS line: 50 ÷ 400 = 0.1250 at the start, 55 ÷ 416 = 0.1322 at the end, a rise of 5.77%. The simple difference (+6.0) gives the same ranking.
- 13-week ranks: A 1, D 2, B 3, C 4. 4-week ranks: D 1, B 2, A 3, C 4.
- Average ranks: A (1 + 3) ÷ 2 = 2.0; B (3 + 2) ÷ 2 = 2.5; C (4 + 4) ÷ 2 = 4.0; D (2 + 1) ÷ 2 = 1.5.
Result: D is the leader on both lookbacks, so it becomes the first place to scan for pullback or breakout setups. A is still strong over the quarter but losing momentum, so it stays on the list with lower priority. B is improving and goes on a watch list. C is weak on both and is excluded from new long trades.
Common mistake
Practice activity
On paper: over 13 weeks the benchmark rises from 200 to 210. Sector E rises from 40 to 44, sector F from 90 to 93, sector G falls from 60 to 57. Calculate each sector's 13-week return, the return difference to the benchmark, and the RS change for sector E. Then rank the three sectors.
Show solution
Benchmark: 10 ÷ 200 = +5.0%.
E: 4 ÷ 40 = +10.0%, difference +5.0. F: 3 ÷ 90 = +3.33%, difference −1.67. G: −3 ÷ 60 = −5.0%, difference −10.0.
RS change for E: 1.10 ÷ 1.05 − 1 = +4.76%.
Ranking: E first, F second, G third. Scan mainly in E; avoid new longs in G.
Limitations: one lookback only; add a 4-week lookback before acting, and remember that past relative strength does not guarantee future relative strength.
Key takeaways
- The RS line (sector ÷ benchmark) shows outperformance even when both fall.
- Ranking on a 13-week and a 4-week lookback separates leaders, fading sectors and improving sectors.
- Use the ranking to focus scans, not as a trade signal on its own.
- Leadership can change quickly; every trade still needs its own stop and size.
Next step
In the next lesson you will learn how to manage several swing positions at once without hidden concentration.
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