Tales of a Technician: Spotting Relative Strength
May 18, 2021
Swing traders are nomads, always on the search for food. High quality chart patterns are their buffalo. And these beasts don’t settle in a single stock. They roam. Of necessity, the swing trader must also roam. One of the tools that I find indispensable when scanning for where to go is relative strength.
Today, I’ll show you how to spot it.
The term”relative” refers to a comparison. It might be comparing a stock to the broad market, its sector, or another stock. When you look at two assets side by side, you can tell which is stronger than the other. In other words, which one has outperformed, or generated higher gains.
Study the following stats:
S&P 500 +2%
Basic Materials Sector +3%
Newmont Corporation (NEM) +4%
Newmont is exhibiting relative strength versus both its sector and the S&P 500. This is attractive in large part because we believe that strength begets more strength. Similar to the adage that “a trend in motion stays in motion,” stocks that are outperforming tend to persist in their muscle flexing.
So how do you spot relative strength? Let’s look at a few methods.
On any given day you can sort your watch list or sector list by % change. The best performers (those with relative strength) will be sitting atop the leader board. But one day could be noise. For that reason it’s often better to look at the price chart and compare the trend trajectory to that of the S&P 500 or some other benchmark you’re using for comparison purposes.
If you want to know which sectors are exhibiting relative strength, then you can use the gridiron in our Tackle Newsletter. Here’s a screenshot of the latest one. Note how the S&P 500 sits at the 20 yard line. Anything to the right of it is showing relative strength versus the broad market. For now, that’s XLB, XLF, and XLI.
Using the same logic, those sectors furthest to the left of the S&P 500 are the ones exhibiting the most relative weakness. Right now that’s XLK and XLY. This is one reason why our scouting reports had so many basic materials on the bull list, and why there were so few technology stock picks.
If you start your daily routine by looking at a chart of the major indexes, then you can keep their posture in your minds eye as you survey the rest of your watchlist. If the S&P 500 is above the 50-day and 20-day moving averages, then I know any sector or stock below its 50-day and 20-day moving averages is exhibiting relative weakness to a certain extent. Here’s another example. If the S&P 500 just made a higher pivot high by breaking through resistance, then any other sector that made a lower high and/or didn’t break resistance is lagging.
Look at the S&P 500 right now and what do you notice? It’s sitting at its 20-day moving average and hasn’t yet made a higher pivot high.
The XLB chart never broke below the 20-day and is a whisker away from making a new high. That’s what relative strength looks like.
If it’s not obvious enough based on the chart, then you can always add the Relative Strength indicator (note- this is not the RSI). This study is plotted as a line that rises when your stock is outperforming whatever you choose as the benchmark (the default is the S&P 500).
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