Relative strength is a way to predict the strength of a given stock, in comparison to another stock, and to then make decisions based upon it. In this study, we will compare stocks and their relative strength to the Index and make decisions on whether to go long or short.
There are two types of relative strength studies:
1. Relative Strength:
In this case, the stock we are scanning is relatively stronger in comparison to the Index. Such a stock can be on the watch list for longs on a breakout.
How to recognize relative strength?
When the stock is making higher highs and higher lows, and in comparison the index is making lower highs and lower lows, relative strength can be identified.
2. Relative Weakness:
In this case the stock is relatively weaker in comparison to the Index. Such a stock can be on the watch list for shorts on a breakdown.
How to recognize relative weakness?
When the stock is making lower highs and lower lows, and in comparison the index is making higher highs and higher lows, relative weakness can be identified.
Let us see a few examples:
In this manner, relative strength can be used for stock selection. This strategy works best in:
1. Relative weakness shorts in stocks where the Index is forming a short term tops
2. Relative strength longs in stocks where the Index is forming a probable bottom after a decline