Deciding where to invest your capital is hard work for both novice and experienced investors alike, identifying the market sectors you would like to include in your portfolio first is basic common sense. Before you drill down into individual companies which you feel could either be undervalued, or you predict will experience strong growth you must first decipher which sectors in the marketplace have the most potential to deliver your initial outlay with the best returns (because of course, you want to make bank in the markets). In order to stand a chance of making the highest percentage gains on your investment it’s important you take a highly logical and rational approach to building your portfolio. Again, it really is just as boring as it sounds, so you will have to find a way of getting your excitement outside of the markets (...take up cross-stitching, pole fitness, or give some classic French pastry baking a whirl).
A macro economic picture is an essential starting block and you can start by looking at global interest rates, alongside monetary and fiscal policies. The reason this information is so crucial to your investing is because if for instance, interest rates are low, then you might assume that stock prices generally, are rising. This is because businesses as a whole tend to borrow huge sums of money, and the more a company is borrowing, investing and growing, then the more likely you are to see its stock value rise in the market. In addition, investors are likely to have a higher percentage of their portfolio tied-up in stocks if interest rates are very low because of the greater returns they can achieve through speculating in this fashion
It’s worth noting that stock values aren’t intrinsically linked to interest rates by any means, however, there is to some extent, a relatively consistent set amount of money tied up in the markets. When one investor makes a profit, the individual who took the opposite side of the trade made a loss, so in real terms the money in the market as a whole stays fairly fixed. With this in mind it’s logical to assume that when a lot of investors take their money out of currency, it goes into a different area of the market. Whether that be precious metals, the latest tech company, or a new start-up; your job as an investor is to speculate in the areas with the most potential.
If Central Banks have quantitative easing measures in place then it’s likely a Government (providing they are not pocketing the cash for themselves) will be spending on a country's infrastructure in areas such as road building, train lines, bridges and airports. This also depends at which stage of a market cycle the economy is in and how likely recession is, but you can certainly look more closely at what is happening specifically in these areas and determine whether they offer an enticing investment opportunity. Quantitative easing of this kind tends to happen after a recession has occurred and a Government is attempting to kick-start the economy back into growth.
After you have a macro economic viewpoint you can then go on to look at which market sectors might provide you with the greatest returns on your outlay. An economy is made up of 11 market sectors, and the companies which make up these sectors can all be traded in the stock markets.
The 11 Market Sectors of an Economy
Once you have a broad overview of the different market sectors you can use macro economic research to further help with deciding which areas you should invest in. If it is apparent that the Central Bank interest rate policy is hawkish, meaning rates are likely to rise in the near future, and you expect this to be the case for some time, then it might be reasonable to assume that mortgages will become less affordable as the cost of borrowing increases; in this situation house prices might react negatively. If you hypothesize a scenario logically, and have come to a conclusion which makes sense, then in this example, you could consider shorting a residential real estate firm in which to add into your portfolio.
Much of the stock market is intertwined and your job as a professional investor is to try and make some kind of sense of the economic climate you find yourself in, and then make reasonable assumptions about where you see things headed. In fact, you have to be incredibly more specific and it is better if you hypothesize actual case studies as to where you see particular companies are going, and provide detailed and pragmatic reasoning as to why you see things playing out this way.
"You are most probably only going to be taking positions in companies which belong in around 4 or 5 of the market sectors as it’s unlikely your conviction will be strong enough to want to trade all eleven market sectors."
As a starting point you can form a bullish or bearish outlook on each of the sectors, and then score each sector out of 100 percent based on how strongly you hold that view. Carrying out some research to form your opinion first is most certainly advised and will have the added advantage of introducing you into some of the larger market players (it’s good to know who the Big Boys are first) before going into individual stock picks.
As opposed to creating your own selection of individual stock picks, there are instruments available to trade known as ETF’s, exchange traded funds. These are a pre-built basket of stocks in a specific market sector, designed to minimize risk. You can use products like this if you want limited exposure in a certain market sector, but it’s always advised to research exactly what’s inside the ETF. I personally believe this is just as time-consuming as simply picking your own stocks to trade.
The companies and stocks you choose to speculate on will make up a percentage of your portfolio, and you will need to leave room to diversify in other trading instruments such as currencies and commodities, as well as a reasonable percentage allocated for day trading. Creating a portfolio that has huge potential to outperform the markets is what you are striving to achieve, and the way you go about choosing which sectors you see fit to invest in, is an area you can use to exploit weaker investors who are not willing to spend the proper amount of time setting up their overall trading strategy to an effective level.