Gain an Edge in the Markets with Relative Strength Charts – Identify Outperformers, Avoid Laggards, and Optimize Your Trading Strategy
Introduction: A broad outline of Relative Strength Charts
Relative Strength (RS) charts are an essential tool in technical analysis, helping traders and investors compare the performance of one security against another — usually a benchmark index or another stock. By analyzing RS charts, traders can pinpoint market leaders and laggards, enhancing their ability to make profitable investment decisions.
Key Takeaways
- RS charts identify outperforming and underperforming assets
- These charts are created by comparing the price of one asset to another through division
- Rising RS lines indicate strength, while falling RS lines indicate weakness
- RS charts aid in sector rotation, risk management, and trend identification
- They work best when used alongside other technical and fundamental analysis tools
Now, let’s dive into their origins and practical applications in trading and investing.
Go to the Relative Strength Charts/Matrix slideshow and demo videos
Also see:
1. RS Rating or Relative Strength Rating (an aid for stock selection in ChartAlert)
2. Relative Rotational Charts (an aid for sectoral rotation and stock selection)
3. RS Matrix or Relative Strength Matrix (an aid for sectoral rotation and stock selection)
3. Stock selection using RS Ratio and RS Rating
4. Stock selection using RS Matrix
Origin of Relative Strength Charts
The Early Foundations
Charles Dow, the father of technical analysis, first introduced the concept of comparing asset performance in the late 19th century through his Dow Theory. This concept laid the foundation for modern relative strength analysis.
A.W. Cohen’s Contribution
A.W. Cohen, associated with Chartcraft, played a significant role in popularizing RS analysis. His main contributions include:
- Relative Strength Rankings: A useful way to evaluate stocks is by comparing them within the same sector to spot the top performers and those lagging behind..
- Differentiating Absolute vs. Relative Strength: Unlike absolute strength, which evaluates an asset in isolation, relative strength focuses on its performance compared to a benchmark.
Thomas Dorsey’s RS Matrix Method
Thomas Dorsey refined RS analysis further by developing the Relative Strength Matrix, a method for ranking assets based on their RS performance. His Point & Figure (P&F) RS charts remain a widely used tool for identifying strong and weak stocks.
Jeremy du Plessis’ Insights
Jeremy du Plessis, author of The Definitive Guide to Relative Strength Investing, provided practical techniques for applying RS analysis in trend identification, risk management, and portfolio optimization.
Constructing Relative Strength Charts
The formula for calculating relative strength is straightforward:
Ratio Chart or Relative Strength (RS) = Price of Asset A ÷ Price of Asset B
Types of Relative Strength Calculations
- Stock vs. Market Index:
RS = Stock Price ÷ Market Index Price
Example: INFY / NIFTY - Stock vs. Another Stock:
RS = Stock Price ÷ Other Stock Price
Example: INFY / TCS
A Point & Figure (P&F) RS Chart helps visualize RS trends:
- X’s indicate outperformance (stock is gaining strength)
- O’s indicate underperformance (stock is weakening)
Why RS Charts Are Crucial for Traders
- RS charts help cut through market noise, offering a clearer way to compare different securities.
- Relative Strength helps identify stocks that are outperforming their peers, making it easier for traders to allocate capital efficiently.
- They expose hidden trends that may not be visible in standard price charts.
The Significance of Relative Strength Charts, and how to effectively make use of them in trading
1. Identifying Outperformance and Underperformance
- When an RS chart is rising, it indicates that a stock is performing better than the market.
- Falling RS charts indicate underperformance, signaling caution.
2. Spotting Momentum and Trends
RS charts help traders identify strong trends. Stocks with consistently rising RS lines are likely to maintain strength, making them potential buying opportunities.
3. Timing Entry and Exit Points
When an RS line starts to rise after a period of underperformance, it may indicate a turnaround. Conversely, a declining RS line suggests weakening strength and potential selling opportunities.
4. Short Selling Opportunities
These charts can also help identify weaker stocks that may be good candidates for short selling. If a stock’s RS line is consistently declining, it suggests continued weakness relative to peers.
5. Using Point & Figure RS Charts for Signals
- RS Buy Signal: Occurs when the RS chart transitions from O’s to X’s, signaling strength, and triggering a P&F double top buy signal.
- RS Sell Signal: Occurs when the RS chart transitions from X’s to O’s, signaling weakness, and triggering a P&F double bottom sell signal.
6. Identifying Positive Divergences
A positive divergence happens when a stock’s price declines while its RS line rises — suggesting underlying strength and potential for reversal.
7. Sector and Industry Rotation
Traders use RS analysis to track sector rotations, shifting investments into outperforming sectors while avoiding weak ones. For example, during an economic upcycle, technology or growth stocks may show rising RS, whereas defensive sectors like utilities may lag. Recognizing these shifts allows investors to adjust their portfolios for maximum profitability.
Also see: Sectoral Rotation or Relative Rotational Charts
8. Portfolio Diversification and Risk Management
RS analysis aids in portfolio optimization by identifying the strongest assets, helping investors manage risk and maximize returns. By regularly analyzing relative strength, investors can focus on top-performing stocks and sectors while avoiding underperformers.
Also see: Stop Loss . . . and its importance in trading – Some ways of setting up stop loss levels – How to set up stop loss and take profit levels in trading
9. Measuring RS Over Different Time Frames
- Short-term traders use daily RS charts for quick trades.
- Long-term investors rely on weekly or monthly RS charts for broader trends.
- Multi-timeframe analysis: Analyzing RS across different timeframes provides a clearer picture of both short-term momentum and long-term trends, improving overall decision-making.
10. Integrating RS with Other Analysis Methods
For the best results, RS charts should be combined with other analysis methods, such as:
- Moving Averages (to confirm trends)
- Trendlines (to validate breakouts)
- Momentum Indicators (such as RSI or MACD for additional confirmation)
- Fundamental Analysis (to assess intrinsic value)
Conclusion: Why Relative Strength Charts Matter
Relative Strength Charts offer a clear, systematic approach to analyzing market trends, making them a must-have tool for traders and investors. Whether you’re identifying strong stocks, timing trades, or managing risk, RS charts enhance decision-making when used alongside other technical indicators. Their ability to reveal market leadership, sector strength, and key reversals makes them an indispensable part of any serious trader’s strategy.
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