One of the key advantages to index investing is that you can be assured that your performance will not be much worse than the major averages. Of course the key disadvantage to index investing is that you will not outperform the averages either.

A quick look at the year end rankings of mutual funds and ETFs almost always has some narrow sector fund like energy or tech stocks leading the gains for the year.

Let's take a quick look at the relative success of sector funds over the last few years. We will use the Fidelity funds family, not that there is necessarily an advantage to using Fidelity, but they have a large offering of funds (over 100 equity funds alone, including domestic sectors and international funds, including country funds) and they have a longer history than most of the exchange traded funds that can be used today for sector trading.

In a previous article we saw that even for the bear market year 2002, which saw the major indices down by better than 20%, there were Fidelity funds that had a positive return for the year. And of course for the stronger market years like 2003 and 2004, there were funds that had much bigger gains than the index funds again.

In fact, from 1999 through 2005, the three best performing funds each outperformed the S&P 500 by at least 30 percent every year. Of course, the worst performing funds performed at least 10 percent worse than the S&P 500 every year as well.

This highlights the great profit potential from sector trading, but also the risks associated with trading without a plan or a system to get you into the strong sectors at the right time while getting you out before the bottom falls out.

Previously we described a simple system using Fidelity Select funds for a sector trading system that had historically returned about 16% a year trading just once a month. This showed that even a simple sector trading system that anyone can trade can yield market beating results.

But a simple one fund system can have above market risk. This simple system had almost a 50% drawdown in the 200-2002 bear market. But the good news is that there are simple changes that can be made to build a trading system that keeps above market returns while significantly reducing the risk of sector trading...