Relative Strength Trading: This is a concept that ties together closely with sector trading, and the two concepts are used in sync with one another.
If you learn how to trade stocks and sectors that have the most relative strength or weakness, you can significantly lower your overall risk in the market, while maximizing your profits at the same time.
A stock is said to have “relative strength” when it is trading at a stronger percentile than the overall market indices, such as the S&P Futures, the Dow Jones Average, or the NASDAQ. This means that whenever the market is going higher, stocks that have relative strength are also going higher, but at a percentage multiple greater than that of the market index you are comparing the stock to. For example, the Dow Jones average may have just jumped up 0.4% higher, but the stock you were in just jumped 1.7% higher during that same time period. Therefore, the stock is said to have relative strength.
Relative strength also means that when the market indices drop lower, stocks that have relative strength drop at a much lower multiple than the indices, or they may not even drop at all. For example, if the NASDAQ just dropped by 1.3% and the stock you are in did not even drop at all during that same time, it could be said that the stock has relative strength.
The inverse of the above is also true, and that is referred to as “relative weakness.” If a stock has relative weakness, that simply means that each time a market index runs higher, the stock does not run at a multiple as high as the market index, and may not even go higher at all. However, when the market index drops lower, a stock with relative weakness will drop much faster and at a more significant multiple than the overall market index to which you are comparing it to.
If you buy stocks that are “following the market,” this is generally not a good thing because we have no certain way of knowing which way the market is going to go. As such, your risk is higher because if the market drops lower, your stock will too. However, if you are in a stock that has relative strength, it is likely that even if the market drops, your stock will not drop at all, or will only drop by a very small amount. Do you see how this decreases your risk? The even better part of this is that if the market does go higher, your stock with relative strength will go even higher than the rest of the stocks that are simply “following the market.”
To summarize, the basic concept is to buy (go long) the stocks that are showing relative strength, sell short the stocks that are showing relative weakness, and not buy stocks that are following the market. By doing so, you will decrease your risk in the market, and maximize your profits. We have our charts set up on RealTick to be able to quickly identify relative strength or weakness of individual stocks or sectors.
Thanks,
Deron |
