Trading with Relative Strength

Do you know that relative strength can help us in trading in stronger stocks? Yes! You heard it right. Relative Strength is a momentum strategy that helps us in identifying strong stocks for trading as compared to the Index. With the help of Relative Strength, traders will look for those companies which have outperformed their peers or the index either by rising more or falling less as compared to the peers or index.

Relative strength helps us in predicting that the trends currently displayed by the stocks will continue for long enough and we can realize a positive return. However, traders should note it is different from the Relative Strength Index.

So, without further delay let us understand what is meant by Relative Strength and how we can trade with it:

What is Relative Strength (RS)?

Relative Strength refers to the measurement of the stock’s performance as compared to its benchmark or another stock. RS compares the performance of stock “X” vs “Y”, measured over a period. For example, “X” may increase more or less than “Y” in a rising market or “X” may fall more or less as compared to “Y” in a falling market. It is one of the tools for momentum investing.

This measure helps us in identifying both the strongest and the weakest securities or any asset classes within the financial market. Usually, the stocks which display strong or weak RS over a given time period tend to continue going forward. One should note that RS analysis can be applied to any domestic or international stocks, stock indexes, fixed income indexes, currencies, commodities, and any other asset classes.

You must have heard about beta and alpha when studying statistics in school? If not, let us recap these concepts in this context. Don’t worry we won’t be too statistical!

Beta and Alpha? Why are we talking about them here?

Beta is a measure of volatility relative to a benchmark, and it’s actually easier to talk about beta first. It helps us in measuring the systematic risk of a security or a portfolio compared to an index like the Nifty 50.

Whereas the Alpha is the excess return on an investment or a stock after adjusting for market-related volatility and random fluctuations. Alpha is one of the major risk management indicators when it comes to analyzing mutual funds, stocks, and bonds. In a sense, it tells investors whether an asset has consistently performed better or worse than its beta predicts. So alpha more than 0 means that a stock has outperformed and less than 0 means that a stock has underperformed after adjusting for volatility.

One should note that the high beta stocks would be more profitable but are also riskier. The high beta stocks could also have a negative alpha which means that although more volatile their trends compared to the Nifty50 could be downward. So when alpha is compared among the stocks it provides us with a relative strength measure and stock lists can be ranked by alpha to show which stocks are the strongest.

Calculation of Relation Strength

Now let us come to the calculation of RS. RS is calculated by using the below formula for comparing a stock’s price change to a change in index prices. 

RS= Stock’s Price / Index’s Price

For calculating the RS of one stock to the another where N is the first stock and N2 is the stock we are comparing it to is as below:

RS= N Stock’s Price/ N2 Stock’s Price

One should note that the period of both the assets should be the same such as one day or one year.

How does Relative Strength work?

Now that we have understood what RS actually means and how we can calculate the same, let us discuss how we can trade stronger stocks using RS with the help of an example-Reliance India Ltd.

In the above daily chart of Reliance India Ltd. We have plotted the RS line compared to Nifty 50 of the last 55 periods.

One should note that when the RS line crosses above 0 then we can say that the stock is outperforming the index and when it crosses below 0 the stock is underperforming the index. So, from the above chart, we can see that on 24^th March, how the RS line crossed the 0 line when the bullish phase of the stock started. This shows that the stock is getting strong and outperforming the index as the prices are moving up. Traders can ride the trend and gain profits till the RS line goes beyond the 0 line.

One should also note that traders should also use other technical indicators such as supertrend, moving average, volume etc. along with the RS line. Also using point and figure charts will help the traders to filter out noise in the market.

But the question comes how we identify the stocks that crossed the 0 line and are either outperforming or underperforming the index or the sectors. For that, we can take the help of StockEdge.

Trading with Relative Strength using StockEdge

StockEdge helps us in filtering the stocks which are either outperforming or underperforming the index or the sectors and other Relative Strength scans as shown below:

For example, the Strongly Outperforming Benchmark Index scan gives us the list of the stocks that have RS>0.1 and denotes that the stocks are outperforming the index.

 After clicking on this scan, we get a list of the stocks outperforming the index as shown below:

Thus, with the help of these scans, we can easily identify those stocks that are either outperforming or underperforming the index or sector in the last 55 days.

Difference between Relative Strength and Relative Strength Index

As we said at the beginning that RS is different from RSI. Relative Strength Index (RSI) is a momentum indicator that measures the magnitude of recent price changes for evaluating overbought or oversold conditions in the price of a stock or other asset. 

The main difference between relative strength and RSI is a difference of perspective. The relative strength tells us about the value of a stock in comparison to another stock, index or sector, whereas the RSI tells about the performance of a stock in comparison to the recent performance of the same stock.

Webinars on Relative Strength:

You can learn more about Relative Strength by watching our webinars conducted by the market experts:

1. BECOME A BLAZING TENDULKAR WITH RS-

One can be successful in trading the stock markets if he has a strong understanding of price movement. Price can give the best probable direction. This webinar conducted by Mr. Premal Parekh will help the traders to identify stock ideas that have the highest chance of success. It will discuss in detail the concepts of Relative Strength, Adaptive Relative Strength & Comparative Relative Strength. Participants will be able to analyse stocks with ease and build conviction for scaling up with trends & initiate larger positions.

2. IDENTIFY MASTER-BLASTER STOCKS WITH RS-

This unique webinar conducted by Mr Premal Parekh will help us in understanding the concepts of Relative Strength, Adaptive Relative Strength & Comparative Relative Strength. Concepts that clearly define baseline rules of Economics – Identifying Demand & Supply.

Learning of these concepts will help the traders to find MASTER BLASTER stocks that consistently outperform the Benchmark Nifty 50. Participants will be able to analyse stocks with ease and build conviction for scaling up with trends and initiate larger positions.

3. SYSTEMATIC TRADING USING RELATIVE STRENGTH/MOMENTUM-

This webinar on systematic trading using Relative Strength/ Momentum conducted by Mr Vivek Gadodia will help the traders to understand How to identify the strongest stocks? It will also help them to understand how to create a basket of stocks and allocate capital, Rebalancing stocks and also Managing Risk.

4. CROSSOVERS & RELATIVE STRENGTH-

This webinar on crossovers and relative strength conducted by Mr Dinesh C Nagpal will help you gain knowledge about the amalgamation of Dow Theory with a modified Relative Strength as the catalyst for momentum-driven trades.

5. TRADING STRATEGY USING “RELATIVE PRICE THEORY”-

Trading is a science that needs a strong understanding of price movement. It is a widely accepted theory in trading that price is God. Why spend so much time on other facets when the price can give you the best probable direction. This webinar on Trading Strategy using Relative Price Theory will equip the participants with the process of identifying stock ideas that have the highest chance of success.

Watch our video on Relative Strength by Mr Vivek Bajaj

Bottomline

One should note that trading with relative strength requires a strategy. Traders should not just randomly buy a strong stock. They still need to follow a trading plan which defines how and where they can enter, how to control risk, position size, and also how to exit the stock. Relative strength gives us an idea of trading in stronger stocks. We hope that you found this blog informative and use the information to its max potential in the practical world.

We hope that you found this blog informative and use the information to its maximum potential in the practical world. Show some love by sharing this blog with your family and friends and help us in our mission of spreading financial literacy.

Happy Trading!!