Relative Strength, Explained


By: Spencer Israel

Last week we wrote about the Relative Strength Index (RSI) and its usefulness as a technical analysis tool for analyzing individual stocks.

RSI is often confused with a concept called relative strength, though the two are completely different things. If RSI is a tool in your toolbox, then relative strength is an entirely separate drawer.

What Is Relative Strength
Relative strength is simply a way of looking at the market by comparing the performance of one asset to the performance of another.

This comparison can be made for any assets that have any sort of historical relationship or correlation, such as one stock to another, a stock to an index, or a stock to an ETF that holds it.

The idea is that this comparison provides context for how two related assets correlate over time and can help identify when that correlation may change or if one asset is disproportionately outperforming or underperforming the other.

Observing Relative Strength
One way to see this comparison is to quantify it. The easiest way to quantify relative strength is to divide the price or percent return over a given time of one asset by the price or percent return of the other.

So, for example, if shares of Pepsi ($PEP) are up 10% over the course of a month, and shares of Coke ($KO) are up 20%, then we can say Pepsi’s relative strength to Coke is 0.5. In other words, Pepsi has been half as strong has Coke.

More commonly however, relative strength can be observed via the eyeball test. Just looking at two assets side-by-side can often be enough to see it.

For example, if shares of Microsoft ($MSFT), the largest holding in the S&P 500, are down 2% while the index is down 3%, then we can say Microsoft is relatively strong for the day.

The more we use relative strength to compare performances, the more clues we can get about market sentiment. If on that same day, Apple ($AAPL), Google ($GOOGL), and Facebook ($FB) are all down 2% along with Microsoft, then we can safely say that, for whatever reason, technology is in favor relative to the rest of the market for that day.

There are several other ways of observing relative strength. Investor’s Business Daily is known for having its own proprietary Relative Strength Rating that tracks a stock’s price over the previous 52 weeks and compares it to the performance of all other stocks.

Using Relative Strength
The simplest way to use relative strength in your daily trading is to keep an eye on the major market meters—the S&P 500, bond yields, gold—and major foreign markets like China to get a feel for what the general market sentiment is. You can then drill down into the 11 individual sectors to understand what’s in favor and out of favor in the U.S. market, or drill even deeper by looking at specific industries. At a micro level, you can compare the performance or related companies.

As you observe these daily relationships over time, you’ll learn to identify when they change in different market conditions and when their correlations get out of whack, allowing you to trade off those inefficiencies.

The author is long all the stocks mentioned above in his 401(k).

Active Trading with Lightspeed
Lightspeed, a division of Lime Brokerage, provides professional traders with all the tools required to help them find success in stock trading, and we have been developing and honing our active trader platform to offer an optimal user experience. With the intuitive interface layouts and institutional quality stock and options scanners, we aim to help traders reach their goals, no matter what their strategy is. We also offer our clients some of the lowest trading fees in the industry.

For more information on a professional trading platform with Lightspeed, please call us at 1-888-577-3123, request a demo or to open an account.

Lime Brokerage LLC is not affiliated with these service providers. Data, information, and material (“content”) is provided for informational and educational purposes only. This content neither is, nor should be construed as an offer, solicitation, or recommendation to buy or sell any securities. Any investment decisions made by the user through the use of such content is solely based on the users independent analysis taking into consideration your financial circumstances, investment objectives, and risk tolerance. Lime Brokerage LLC does not endorse, offer or recommend any of the services nor information provided by any of the above service providers and any service or information used to execute any trading strategies are solely based on the independent analysis of the user.

You may also be interested in...

The IPOX® Week, July 13, 2020
Read More
Brace Yourselves. Earnings Are Coming.
Read More
The IPOX® Week, July 6, 2020
Read More
Revenge Of The SPACs
Read More

Try the demo

Compare Platforms
Check the background of this firm on FINRA's BrokerCheck

Our website uses cookies to improve the performance of our site, to analyze the traffic to our site, and to personalize your experience of the site. You can control cookies through your browser settings. Please find more information on the cookies used on our site in our Privacy Policy. By clicking OK, you agree to allow us to collect information through cookies.

OK