In the financial markets, buying and selling stocks would be disorganized were it not for some type of categorization. An industry group contributes to order in the stock market. It is a category of like corporations with similar business lines and models that can be compared with one another. Often, companies in the same industry group compete with one another. An industry group can be broad, such as a grouping of industrial stocks, or it could be quite specific and include only steel companies, for instance.
There are different ways to illustrate how individual industry groups are fairing in the economy. Throughout the stock market, companies in the same industry group sometimes will be included in what's known as a sector index. For instance, companies that drill oil and gas are considered to be in the same industry group. In order to represent how this category of companies is fairing in the financial markets, a regional stock market might create what's known as an oil services index, where performance of corporations in this category is measured. Viewing index performance might help investors to determine whether they have the risk/reward profile that is required to invest in stocks in that particular grouping.
Often, stocks in an industry group trade, or are bought and sold, in a similar fashion to one another. When there is a news in a specific industry stock, other securities in that grouping tend to react. For instance, negative news in the energy industry at one industry-leading company can result in the entire sector trading lower. When an industry leader falls out of favor with investors, the entire industry group often can be punished as a result. This could be because the fear that one negative event also will have a negative effect on similar companies.
Investing in multiple industry groups, or sectors, is one way to add diversification into an investment portfolio and eliminate some of the risk associated with having too much exposure to one sector. Particularly by investing across different sectors, especially industry groups that are unassociated with one another, investment risk is mitigated. Spreading investments across various groups is known as asset allocation.
The benefit of asset allocation is that if one sector is performing especially strong for a period of time, these gains will compensate for other equity exposure in a portfolio that might be on the decline. For instance, by investing both in energy stocks and pharmaceutical stocks, one of these industry groups might contribute to an investor's profits if the other sector is experiencing losses. There are times in the financial markets, however, when most all industry groups are trading in a like direction, and this typically occurs when there is a larger piece of news circulating that might be tied to broader economic developments.