Relative Strength

What Is Relative Strength?

Relative strength is a strategy utilized in momentum investing and in recognizing value stocks. It centers around investing in stocks or different investments that have performed well relative to the market as a whole or to a significant benchmark. For instance, a relative strength investor could choose technology companies that have outperformed the Nasdaq Composite Index, or stocks that are outperforming the S&P 500 index.

Technical analysts utilize an indicator known as the relative strength index (RSI) to create overbought or oversold signals.

Figuring out Relative Strength

While the goal of value investing is to buy low and sell high, the goal of relative strength investing is to buy high and sell even higher. Thusly, relative strength investors expect that the trends as of now shown by the market will go on for enough time to allow them to realize a positive return. Any sudden reversal to that trend will lead to negative outcomes.

To recognize investment up-and-comers, relative strength investors start by noticing a benchmark like the Nasdaq Composite Index. They will then hope to see which companies inside that market have outperformed their friends, either by rising more quickly than their friends or by falling less quickly than them.

Since relative strength investing accepts that current trends will go on into the future, it is best in stable periods with negligible disruption. On the other hand, tumultuous periods, for example, the 2007-2008 financial crisis can be dangerous for relative strength investors since they can lead to sharp reversals of investment trends. In those circumstances, investor psychology can suddenly reverse, with the previous investment sweethearts suddenly being evaded.

In spite of the fact that momentum investing is frequently associated with individual stocks, it can likewise be applied to whole markets or industry sectors utilizing index funds and exchange traded funds (ETFs). Additionally, investors can make relative strength investments in other asset classes, for example, in real estate, utilizing real estate investment trusts (REITs). More exotic instruments, for example, commodity futures, options, and other derivative products, can likewise be utilized.

Strategies Employing Relative Strength

Relative strength investing can likewise be utilized as one part of a bigger strategy, for example, pairs trading.

Real-World Example of Relative Strength

Harry is a relative strength investor who watches out for corporate bond prices and the S&P 500. His investment portfolio comprises of a S&P 500 index fund and an ETF that tracks the corporate bond market. As a relative strength investor, he intermittently builds his allocation toward whichever asset is outperforming around then. In doing as such, he desires to benefit from the continuing trend of that asset's outperformance, effectively buying high and selling higher.

In recent months, he has seen that investors appear to be expanding their portfolio bond allocations to the detriment of stocks. This inflow of money into the bond market has been raising bond prices and lowering yields.

Anticipating that this trend should proceed, Harry answers by decreasing his investment in the S&P 500 and expanding his investment in the corporate bond ETF. He desires to benefit from any continuous outperformance of bonds relative to stocks.

Relative Strength Index (RSI)

Short-term and technical traders likewise check relative strength out. In technical analysis, the relative strength index (RSI) is a momentum indicator that measures the extent of recent price changes to assess overbought or oversold conditions in the price of a stock or other asset. The RSI is shown as an oscillator (a line graph that moves between two limits) and can have a perusing from 0 to 100. The indicator was initially developed by J. Welles Wilder Jr. also, presented in his original 1978 book, "New Concepts in Technical Trading Systems."

Customary interpretation and use of the RSI are that values of 70 or above demonstrate that a security is becoming overbought or overvalued and might be primed for a trend reversal or corrective pullback in price. A RSI perusing of 30 or below demonstrates an oversold or undervalued condition.

Highlights

• It comprises of choosing investments that have been outperforming their market or benchmark.
• Relative strength investors accept that the trend of outperformance will proceed. Assuming that the trend reverses, their investment will probably perform ineffectively.
• Relative strength is a type of momentum investing utilized by technical analysts and value investors.