Sector Rotation Analysis: A Practical Tutorial Using TradingViewSector Rotation Analysis: A Practical Tutorial Using TradingView
Overview
Sector rotation is an investment strategy that involves reallocating capital among different sectors of the economy to align with their performance during various phases of the economic cycle. While academic studies have shown that sector rotation does not consistently outperform the market after accounting for transaction costs, it remains a popular framework for portfolio management.
This tutorial provides a step-by-step guide to analyzing sector rotation and identifying leading and lagging sectors using TradingView .
Understanding Sector Rotation and Economic Cycles
The economy moves through distinct phases, and each phase tends to favor specific sectors:
1. Expansion : Rapid economic growth with rising consumer confidence.
- Leading Sectors: Technology AMEX:XLK , Consumer Discretionary AMEX:XLY , Industrials AMEX:XLI
2. Peak : Growth slows, and inflation may rise.
- Leading Sectors: Energy AMEX:XLE , Materials AMEX:XLB
3. Contraction : Economic activity declines, and unemployment rises.
- Leading Sectors: Utilities AMEX:XLU , Healthcare AMEX:XLV , Consumer Staples AMEX:XLP
4. Trough : The economy begins recovering from a recession.
- Leading Sectors: Financials AMEX:XLF , Real Estate AMEX:XLRE
Step 1: Use TradingView to Monitor Economic Indicators
Economic indicators provide context for sector performance:
GDP Growth : Signals expansion or contraction.
Interest Rates : Rising rates favor Financials; falling rates benefit Real Estate.
Inflation : High inflation supports Energy and Materials.
Step 2: Analyze Sector Performance Using Relative Strength
Relative Strength RS compares a sector's performance against a benchmark index like the
SP:SPX This helps identify whether a sector is leading or lagging.
How to Calculate RS in TradingView
Open a chart for a sector TSXV:ETF , such as AMEX:XLK Technology.
Add SP:SPX as a comparison symbol by clicking the Compare ➕ button.
Analyze the RS line:
- If RS trends upward, the sector is outperforming.
- If RS trends downward, the sector is underperforming.
Using Indicators
e.g.: You may add the Sector Relative Strength indicator from TradingView’s public library. This tool ranks multiple sectors by their relative strength against SP:SPX
Additionally, you can use the RS Rating indicator by @Fred6724, which calculates the Relative Strength Rating (1 to 99) of a stock or sector based on its 12-month performance compared to others in a selected index.
Example
In early 2021, during economic recovery, AMEX:XLK 's RS rose above SP:SPX , signaling Technology was leading.
Step 3: Validate Sector Trends with Technical Indicators
Technical indicators can confirm sector momentum and provide entry/exit signals:
Moving Averages
Use 50-day and 200-day Simple Moving Averages SMA.
If a sector TSXV:ETF trades above both SMAs, it indicates bullish momentum.
Relative Strength Index RSI
RSI > 70 suggests overbought conditions; <30 indicates oversold conditions.
MACD Moving Average Convergence Divergence
Look for bullish crossovers where the MACD line crosses above the signal line.
Example
During the inflation surge in 2022, AMEX:XLE Energy traded above its 200-day SMA while RSI hovered near 70, confirming strong momentum in the Energy sector.
Step 4: Compare Multiple Sectors Simultaneously
TradingView allows you to overlay multiple ETFs on one chart for direct comparison:
Open AMEX:SPY as your benchmark chart.
Add ETFs like AMEX:XLK , AMEX:XLY , AMEX:XLU , etc., using the Compare tool.
Observe which sectors are trending higher or lower relative to AMEX:SPY
Example
If AMEX:XLK and AMEX:XLY show upward trends while AMEX:XLU remains flat, this indicates cyclical sectors like Technology and Consumer Discretionary are outperforming during an expansion phase.
Step 5: Implement Sector Rotation in Your Portfolio
Once you’ve identified leading sectors:
Allocate more capital to sectors with strong RS and bullish technical indicators.
Reduce exposure to lagging sectors with weak RS or bearish momentum signals.
Example
During post-pandemic recovery in early 2021:
Leading Sectors: Technology AMEX:XLK and Industrials AMEX:XLI
Lagging Sectors: Utilities AMEX:XLU
Investors who rotated into AMEX:XLK and AMEX:XLI outperformed those who remained in defensive sectors like AMEX:XLU
Real-Life Case Studies of Sector Rotation
Case Study 1: Post-Pandemic Recovery
In early 2021, as economies reopened after COVID-19 lockdowns:
Cyclical sectors like Industrials AMEX:XLI and Financials AMEX:XLF outperformed due to increased economic activity.
Defensive sectors like Utilities AMEX:XLU lagged as investors shifted away from safe havens.
Using TradingView’s heatmap feature , investors could have identified strong gains in AMEX:XLI and AMEX:XLF relative to AMEX:SPY
Case Study 2: Inflation Surge in Late 2022
As inflation surged in late 2022:
Energy AMEX:XLE and Materials AMEX:XLB outperformed due to rising commodity prices.
Technology AMEX:XLK underperformed as higher interest rates hurt growth stocks.
By monitoring RS lines for AMEX:XLE and AMEX:XLB on TradingView charts, investors could have rotated into these sectors ahead of broader market gains.
Limitations of Sector Rotation Strategies
Transaction Costs : Frequent rebalancing can erode returns over time.
Market Timing Challenges : Predicting economic cycles accurately is difficult and prone to errors.
False Signal s: Technical indicators like MACD or RSI can produce false positives during volatile markets.
Historical Bias : Backtested strategies often fail when applied to future market conditions.
Conclusion
Sector rotation is a useful framework for aligning investments with macroeconomic trends but should be approached with caution due to its inherent limitations. By leveraging TradingView ’s tools, such as relative strength analysis, heatmaps, and technical indicators, investors can systematically analyze sector performance and make informed decisions about portfolio allocation.
While academic research shows that sector rotation strategies do not consistently outperform simpler approaches like market timing or buy-and-hold strategies, they remain valuable for diversification and risk management when used judiciously.
