Technology Sector Trading Strategy: Rules, Backtest, and Practical Example

The information technology sector has the highest weighting in the S&P 500 index, representing more than a quarter of the index’s market cap. Over the last decade, the sector has been “hot” and had a spectacular bull market.

In this article, we take a brief look at the biggest stocks in the sector, and we make a technology sector trading strategy (actually we make two technology sector trading strategies). The technology sector is a very good trading vehicle. 

Let’s take a look at the sector and do some backtests.

What is the S&P technology sector?

The S&P 500 Information Technology sector consists of those companies included in the S&P 500 that are classified as members of the GICS information technology sector — a sector that covers companies that develop or distribute technological items or services, including computers, microprocessors, and operating systems.

While some companies in this sector focus on creating software or providing services related to implementing technological solutions, others are more involved in building the equipment, components, and hardware that make tech possible. So, the sector also includes makers of semiconductors and the equipment used in producing semiconductor chips.

The major ETFs that track the Information technology sector include the Vanguard Information Technology ETF (VGT) and the Technology Select Sector SPDR Fund (XLK).

What are the 5 biggest stocks in the sector?

The top 5 stocks in this sector include:

1. Apple Inc. (AAPL): The tech giant manufactures and markets smartphones, personal computers, tablets, wearables, and accessories. These include the iPhone series, a line of smartphones; Mac, a line of personal computers; iPad, a line of multi-purpose tablets; AirPods Max, an over-ear wireless headphone; wearables, such as Apple Watch; and electronics — Apple TV. It also provides AppleCare support services and cloud services store services, as well as operates various platforms, including the App Store that allow customers to discover and download applications and digital content, such as books, music, video, games, and podcasts. Apple is the most valued company in the S&P 500 index, with a market cap of $2.48 trillion as of July 20, 2022.
2. Microsoft Corporation (MSFT): The company develops, licenses, and supports software, services, devices, and solutions worldwide. Its offerings include Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, Skype for Business, Client Access Licenses (CAL), Skype, Outlook.com, OneDrive, LinkedIn, and Dynamics 365 — a set of cloud-based and on-premises business solutions for organizations and enterprise divisions. The company also offers cloud services, including SQL, Windows Servers, Azure, Visual Studio, System Center, and GitHub, which provides a collaboration platform and code hosting service for developers. It is the second most valued company in the S&P 500 index, with a market cap of about $2 trillion as of July 2022.
3. NVIDIA Corporation (NVDA): The company provides graphics and other microchips used in computing and networking solutions all over the world. Its products are used in gaming, professional visualization, data center, and automotive markets. The company sells its products to original equipment manufacturers and system builders. Its market cap is $444.847 billion as of July 2022.
4. Broadcom Inc. (AVGO): The company develops and supplies various semiconductor devices with a focus on complex digital and mixed signal complementary metal oxide semiconductor-based devices and analog III-V based products worldwide. As of July 20, 2022, the stock has a market cap of $208.632 billion.
5. Adobe Inc. (ADBE): The company operates as a diversified software venture, serving clients from across the world. It offers products and services that enable individuals and businesses to create, publish, and promote content. These include Document Cloud, a unified cloud-based document services platform, and Creative Cloud, a subscription service that allows members to access its creative products. It also offers e-learning solutions, technical document publishing, and web conferencing. The stock’s market cap as of July 2022 is $187.502 billion.

Please keep in mind that the sector is very volatile in the sense that very few stocks remain in the top spot for a long time. To better understand why it’s like this we recommend our article Do Stocks Outperform Treasury Bills? Many tech stocks fade into obscurity.

Let’s go on to backtest some technology trading strategies:

Technology sector trading strategy no. 1 (XLK trading strategy)

Trading Rules

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The equity curve looks like this:

The number of trades is 245, the average gain per trade is 0.96%, CAGR is 10% (buy and hold is 8%), time spent in the market is 12%, max drawdown is 18%, the win rate is 71%, and the profit factor is 3.1.

You’ll get the code if you subscribe to our package of “code for all our free articles”. Since we started the website in 2012 we have gathered all the code and the logic in plain English for all strategies that we have revealed. It’s over 120 trading ideas for a very reasonable amount. You find all the info on this link:

• Code And Logic For All Free Strategies/Articles

Technology sector trading strategy no. 1 (XLK trading strategy)

We have made a second technology trading strategy. The strategy is almost the same as our monthly trading edge of August 2021, except that the sell rule is slightly changed. The buy condition is based on one single variable.

This is what the equity curve looks like:

The number of trades is 212, the average gain is 1.05%, the win ratio is 70%, CAGR is 9.5%, max drawdown is 15%, time spent in the market is 10%, and the profit factor is 2.85.

Other sector trading strategies

We have covered all the different subsectors in the S&P 500:

• Sector trading strategy
• Industrials Sector Trading Strategy
• Real Estate Sector Trading Strategy
• Consumer Discretionary Sector Trading Strategy
• Financial Services Sector Trading Strategy
• Materials Sector Trading Strategy
• Healthcare Sector Trading Strategy
• Energy Sector Trading Strategy
• Communication Services Sector Trading Strategy
• Biotech trading strategy
• Homebuilder trading strategy

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Technology sector trading strategy – ending remarks

One of the most important things in trading is to focus on the “low hanging fruit”. This is one of the most important lessons from Jim Simons, and he referred to mean reversion strategies. Mean reversion works great for broad market indices like S&P 500 and QQQ, but also for the technology sector.

In this article we made 2 technology trading strategies – both based on mean reversion. However, any technology sector trading strategy might correlate strongly with the broader market and thus offer very little diversification benefits.

FAQ:

Can you explain the significance of the technology sector in the S&P 500?

The S&P 500 Information Technology sector comprises companies in the S&P 500 classified as members of the GICS information technology sector. The technology sector has the highest weighting in the S&P 500, representing over a quarter of the index’s market cap. It has experienced significant growth over the last decade, making it a notable player in the market.

What are the major ETFs tracking the Information Technology sector?

The major ETFs include the Vanguard Information Technology ETF (VGT) and the Technology Select Sector SPDR Fund (XLK). The top 5 stocks include Apple Inc. (AAPL), Microsoft Corporation (MSFT), NVIDIA Corporation (NVDA), Broadcom Inc. (AVGO), and Adobe Inc. (ADBE).

Can you share details about the XLK trading strategy mentioned in the article?

There are two XLK trading strategies discussed. The first involves mean-reversion indicators, and the second is similar to the August 2021 trading edge. Details include trade numbers, average gains, CAGR, time in the market, drawdown, win rate, and profit factor. The code and logic for all free articles, including the XLK trading strategies, can be obtained by subscribing to the package available on the website since 2012.