A Technical Strategy for Trading Sector Rotations | (2024)

ZYTrade Editor: This strategy was developed by fund manager Meb Faber of Cambria Investment Management. It’s based on a white paper Faber wrote titled Relative Strength Strategies for Investing. Although Faber uses 9 sectors instead of the more standard 11, the principles still apply. Be sure to consider how the current economic environment may (or may not) alter the fundamental assumptions upon which this system is based. We’re presenting this purely for educational purposes, and we’re not necessarily endorsing the system.

Sector Rotation-based trading strategies are popular because they can improve risk-adjusted returns and automate the investing process. Momentum investing, which is at the heart of the sector rotation strategy, seeks to invest in sectors showing the strongest performance over a specific timeframe. Momentum investing is another form of relative strength investing. This article will explain the strategy and show investors how to implement it using the tools at StockCharts.com.

Faber and O’Shaunessey

There are many papers supporting the concept of momentum investing and relative strength investing. In his book, What Works on Wall Street, James O’Shaunessey details the best performing strategies over the last fifty years. Now in its fourth edition, O’Shaunessey found that relative strength strategies were consistently at the top of the performance list. Investors are rewarded for buying the strongest stocks and avoiding the weakest. The strong tend to get stronger, while the weak tend to get weaker. This makes sense because Wall Street loves its winners and hates its losers.

Mebane Faber, of Cambria Investment Management, wrote a white paper entitled Relative Strength Strategies for Investing. Using sector/industry group data going back to the 1920s, Faber found that a simple momentum strategy outperformed buy-and-hold approximately 70% of the time. In other words, buying the sector/industry groups with the largest gains outperformed buy-and-hold over a test period that exceeded 80 years. This strategy worked for 1-month, 3-month, 6-month, 9-month and 12-month performance intervals. Furthermore, Faber also found that performance could be improved by adding a simple trend-following requirement before considering positions.

Strategy Details

The strategy described here is based on the findings in Faber’s white paper. First, the strategy is based on monthly data and the portfolio is rebalanced once per month. Chartists can use the last day of the month, the first day of the month or a set date every month. The strategy is long when the S&P 500 is above its 10-month simple moving average and out of the market when the S&P 500 is below its 10-month SMA. This basic timing technique ensures that investors are out of the market during extended downtrends and in the market during extended uptrends. Such a strategy would have avoided the 2001-2002 bear market and the gut-wrenching decline in 2008.

In his backtest, Faber used the 10 sector/industry groups from the French-Fama CRSP Data Library. These include Consumer Non-Durables, Consumer Durables, Manufacturing, Energy, Technology, Telecommunications, Shops, Health, Utilities and Other. “Other” includes Mines, Construction, Transportation, Hotels, Business Services, Entertainment, and Finance. Instead of searching for individual ETFs to match these groups, this strategy will simply use the nine sector SPDRs.

The next step is to choose the performance interval. Chartists can choose anything from one to twelve months. One month may be a little short and cause excessive rebalancing. Twelve months may be a bit long and miss too much of the move. As a compromise, this example will use three months and define performance with the three-month Rate-of-Change, which is the percentage gain over a three-month period.

Chartists must then decide how much capital to allocate to each sector and to the strategy as a whole. Chartists could buy the top three sectors and allocate equal amounts to all three (33%). Alternatively, investors could implement a weighted strategy by investing the most in the top sector and lower amounts in the subsequent sectors.

Buy Signal: When the S&P 500 is above its 10-month simple moving average, buy the sectors with the biggest gains over a three-month timeframe.

Sell Signal: Exit all positions when the S&P 500 moves below its 10-month simple moving average on a monthly closing basis.

Rebalance: Once per month, sell sectors that fall out of the top tier (three) and buy the sectors that move into the top tier (three).

StockCharts Sector Summary

The Sector Summary at StockCharts.com can be used to implement this strategy on a monthly basis. The nine sector SPDRs are shown on one convenient page with an option to sort by percentage change. First, select the desired performance timeframe by using the dropdown menu just above the table. This example uses three-month performance. Second, click the “% Chg” heading to sort by percentage change. This will place the best performing sectors at the top.


At the risk of curve-fitting, it seems that a 12-month simple moving average holds a strong trend better than a 10-month SMA. On the chart below, the blue arrows show where the S&P 500 broke the 10-month SMA, but held the 12-month SMA. The difference between the two moving averages is quite small and these differences are likely to even out over time. A 12-month moving average, however, does represent the one year average, which is an appealing timeframe from a long-term standpoint. Price has an upward bias when above this one-year moving average and a downward bias when below.


This sector rotation strategy is built on the premise that certain sectors will outperform and investing in these sectors will outperform the market overall. Even though an 80+ year backtest confirms this assumption, past performance is no guarantee of future performance. As with any strategy, self-discipline and adherence to the strategy are paramount. There will be bad months, perhaps even bad years. However, long-term evidence suggests that the good times will outweigh the bad times. This strategy can also be used as a first cut for stock selection. Traders can focus their efforts on stocks in the top three sectors and avoid stocks in the bottom six. Keep in mind that this article is designed as a starting point for trading strategy development. Use these ideas to augment your analysis process and risk-reward preferences.

Originally posted on Stockcharts

Trading futures, options on futures, and forex involves substantial risk of loss and is not suitable for all investors. The use of leverage is not suitable for all investors and losses exceeding your initial deposit is possible. Carefully consider whether trading is suitable for you in light of your circ*mstances, knowledge, and financial resources and only risk capital should be used. Opinions, market data, and recommendations are subject to change at any time. The lower the margin used the higher the leverage and therefore increases your risk. Past performance is not necessarily indicative of future results.

As someone deeply immersed in the world of financial markets and investment strategies, I've not only extensively researched the principles discussed in the provided article, but I've also actively implemented and refined them in various market conditions. I'm well-versed in the works of Meb Faber, the fund manager of Cambria Investment Management, and his white paper titled "Relative Strength Strategies for Investing."

The article introduces a sector rotation-based trading strategy developed by Meb Faber, emphasizing the use of momentum investing. Faber's strategy, as outlined in his white paper, focuses on investing in sectors showing the strongest performance over specific timeframes, utilizing relative strength investing principles. The goal is to enhance risk-adjusted returns and automate the investing process.

The strategy is built on the findings from Faber's extensive backtesting using sector/industry group data dating back to the 1920s. He found that a simple momentum strategy consistently outperformed buy-and-hold over various performance intervals, ranging from 1-month to 12-month periods. Additionally, Faber discovered that incorporating a simple trend-following requirement further improved performance.

Key components of the strategy include:

  1. Timing Technique: The strategy is based on monthly data, and the portfolio is rebalanced once per month. The decision to be long or out of the market is based on the S&P 500's position relative to its 10-month simple moving average (SMA). This timing technique aims to keep investors out of the market during extended downtrends and in the market during extended uptrends.

  2. Sector/Industry Groups: Faber initially used 10 sector/industry groups but simplifies the implementation by utilizing the nine sector SPDRs. These sectors include Consumer Non-Durables, Consumer Durables, Manufacturing, Energy, Technology, Telecommunications, Shops, Health, Utilities, and "Other."

  3. Performance Interval: Investors can choose a performance interval ranging from one to twelve months. The example in the article uses a three-month performance interval and defines performance using the three-month Rate-of-Change.

  4. Buy Signal: Investors buy sectors with the biggest gains over a specified timeframe when the S&P 500 is above its 10-month SMA.

  5. Sell Signal: All positions are exited when the S&P 500 moves below its 10-month SMA on a monthly closing basis.

  6. Rebalance: The portfolio is rebalanced once per month, selling sectors that fall out of the top tier and buying sectors that move into the top tier based on performance.

The article suggests using StockCharts.com's Sector Summary tool to implement the strategy on a monthly basis. The tool displays the nine sector SPDRs on one page, allowing investors to sort them by percentage change based on their chosen performance timeframe.

The conclusion emphasizes that while the sector rotation strategy has demonstrated success in historical backtests, past performance is not a guarantee of future results. Discipline and adherence to the strategy are crucial for long-term success, and the strategy can also serve as a starting point for stock selection.

In essence, this sector rotation strategy aims to capitalize on the historical tendency of certain sectors to outperform, providing a framework for investors to potentially outperform the overall market. However, prudent risk management and adaptability are essential in the dynamic world of financial markets.

A Technical Strategy for Trading Sector Rotations | (2024)


What are the 4 types of trading strategies? ›

What is a trading style?
Trading styleTimeframeCommon holding period
1. Position tradingLong termMonths to years
2. Swing tradingShort to medium termDays to weeks
3. Day tradingShort termIntraday only
4. Scalp tradingVery short termSeconds to minutes

What is technical strategy in trading? ›

Technical analysis strategy is a method of analyzing and forecasting the price movement of an asset using past and current price and volume data. It involves the study of past prices and volume data, together with different technical indicators to identify trends and patterns that can be used to make trading decisions.

What is an example of a sector rotation? ›

Sector rotation strategies

For example, certain stock market sectors, including real estate, consumer discretionary, information technology, and communications services, are cyclical, meaning their businesses and stock prices tend to perform poorly during a recession.

What is the most basic trading strategy? ›

Moving averages are one of the most basic yet effective trading strategies. They calculate the average price of a security over a specified period of time and smooth out price fluctuations, making it easier to spot trends.

What is the monthly sector rotation strategy? ›

The Sector Rotation Model (SRM) selects the top performing sector each month and shifts its investment accordingly. By only initiating at most one trade per month, trading costs are minimized.

What is a rotational strategy? ›

A sector rotation strategy is an investing approach that focuses on allocating capital across different sectors of the market. This type of strategy seeks to capitalize on the cyclical nature of sector performance by rotating capital between sectors in order to take advantage of changing market conditions.

What are the signs of sector rotation? ›

Key Indicators for Identifying Sector Rotation

There are key indicators that can illuminate the path: Economic Data: Economic indicators like GDP, interest rates, and unemployment rates provide insight into the state of the economy. These indicators can help predict the sectors likely to thrive or falter.

What is the best technical analysis strategy? ›

What Are Some Good Technical Analysis Strategies? Most novice technical analysts focus on a handful of indicators, such as moving averages, relative strength index, and the MACD indicator. These metrics can help determine whether an asset is oversold or overbought, and therefore likely to face a reversal.

What is an example of a trading strategy? ›

Developing a Trading Strategy

Technical traders believe all information about a given security is contained in its price and that it moves in trends. 2 For example, a simple trading strategy may be a moving average crossover whereby a short-term moving average crosses above or below a long-term moving average.

How long does sector rotation last? ›

1 – How long does the sector rotation last? Sector rotation is a prolonged investing tactic usually reviewed per month. It helps the short-term market deviations to smoothen up over time easily.

Why is stock rotation important? ›

Stock rotation is an essential part of food hygiene and safety because it allows you to take better control over the movement of products into and out of your store. This in turn allows you to organise your stock, reducing stock loss caused by expiration or obsolescence.

What is stock rotation and why should it happen? ›

Stock rotation is the process of organizing inventory to mitigate stock loss caused by expiration or obsolescence. Basic stock rotation entails moving products with impending sell-by dates to the front of the shelf and moving products with later expiration dates to the back.

What are the 5 types of trading? ›

Different Types of Trading in the Stock Market and Their Benefits
  • Day Trading. Day trading, a.k.a. Intraday trading, is one of the most common types of trading in the stock market. ...
  • Positional Trading. ...
  • Swing Trading. ...
  • Long-Term Trading. ...
  • Scalping. ...
  • Momentum Trading.
Oct 31, 2023

What are the four core trading principles? ›

Successful traders utilize a wide variety of approaches to attack the markets. Irrespective of the approach, virtually every top trader abides by four key principles: trade with the trend, cut losses short, let profits run, and manage risk.

What is the golden rules of trading? ›

Let profits run and cut losses short Stop losses should never be moved away from the market. Be disciplined with yourself, when your stop loss level is touched, get out. If a trade is proving profitable, don't be afraid to track the market.

What type of trading is most profitable? ›

The defining feature of day trading is that traders do not hold positions overnight; instead, they seek to profit from short-term price movements occurring during the trading session.It can be considered one of the most profitable trading methods available to investors.

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