7/13/2020 Relative Strength Defined

PART OF
Guide to Technical Analysis

TRADING TECHNICAL ANALYSIS

Relative Strength
By JASON FERNANDO | Updated May 19, 2020

What Is Relative Strength?

Relative strength is a technique used in momentum investing and identifying value stocks. It
consists of investing in securities that have performed well, relative to their market or
benchmark. For example, a relative strength investor might select technology companies that
have outperformed the Nasdaq Composite Index, or large cap stocks that are laggards against
the S&P 500 index.

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7/13/2020 Relative Strength Defined

PART OF
Guide to Technical Analysis

KEY TAKEAWAYS
Relative strength is a type of momentum investing used by technical analysts and
value investors.
It consists of selecting investments that have been outperforming their market or
benchmark.
Relative strength investors assume that the trend of outperformance will continue. If
the trend reverses, their investment will likely perform poorly.

Understanding 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. As such, relative strength investors assume that the
trends currently displayed by the market will continue for long enough that they can realize a
positive return. Any sudden reversal to that trend is likely to lead to negative results.

To identify investment candidates, relative strength investors will begin by observing a

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benchmark, such as the Nasdaq Composite Index. They will then look to see which companies

within that market have outperformed their peers, either by rising more rapidly than their peers
PART OF
or by falling
Guideless rapidly thanAnalysis
to Technical them.

Because relative strength investing assumes that present trends will continue into the future, it
is most effective in stable periods with minimal disruption. By contrast, chaotic periods such as
the 2007–2008 financial crisis can be dangerous for relative strength investors because they can
lead to sharp reversals of the previous investment trends. In those situations, investor
psychology can suddenly reverse itself, with yesterday's investment darlings quickly becoming
shunned by investors.

Although momentum investing is often associated with individual stocks, it can also be applied
to whole markets or industry sectors using index funds and exchange-traded funds (ETFs).
Similarly, investors can make relative strength investments in other asset classes, such as in real
estate using real estate investment trusts (REITs). More exotic instruments, such as commodity
futures, options, and other derivative products, can also be used.

Important: Relative strength investing can also be used as one component of a

larger strategy, such as pairs trading.

Real World Example of Relative Strength

Harry is a relative strength investor who keeps a close eye on corporate bond prices and the
S&P 500. His investment portfolio consists of an S&P 500 index fund and an ETF that tracks the
corporate bond market. As a relative strength investor, he periodically increases his allocation
toward whichever asset is outperforming at that time. In doing so, he hopes to benefit from the
continuing trend of that asset's outperformance, effectively buying high and selling higher.

In recent months, he has noticed that investors seem to be increasing their portfolio bond
allocations at the expense of stocks. This inflow of money into the bond market has been raising
bond prices and lowering yields.

Expecting this trend to continue, Harry responds by decreasing his investment in the S&P 500
and increasing his investment in the corporate bond ETF. He hopes to benefit from any ongoing
outperformance of bonds relative to stocks.

Relative Strength Index (RSI)

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7/13/2020 Relative Strength Defined
Short-term and technical traders also look at relative strength. In technical analysis, the relative
strength index (RSI) is a momentum indicator  that measures the magnitude of recent price
changes to evaluate overbought or oversold conditions in the price of a stock or other asset.
PART OF
The RSI is displayed
Guide as an oscillator
to Technical Analysis(a line graph that moves between two extremes) and can
have a reading from 0 to 100. The indicator was originally developed by J. Welles Wilder Jr. and
introduced in his seminal 1978 book, "New Concepts in Technical Trading Systems."

Traditional interpretation and usage of the RSI are that values of 70 or above indicate that a
security is becoming overbought or overvalued and may be primed for a trend reversal or
corrective pullback in price. An RSI reading of 30 or below indicates an oversold
or undervalued condition.

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Guide to Technical Analysis

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

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Related Terms
LEARN MORE
Oversold Definition
Oversold is a term used to describe when an asset is being aggressively sold, and in some cases may have
dropped too far. Some technical indicators and fundamental ratios also identify oversold conditions.
more

Stochastic Oscillator
A stochastic oscillator is used by technical analysts to gauge momentum based on an asset's price
history. more

Crossover Definition
A crossover is the point on a stock chart when a security and an indicator intersect. more

Relative Strength Index (RSI)

The Relative Strength Index (RSI) is a momentum indicator that measures the magnitude of recent price
changes to analyze overbought or oversold conditions. more

Moving Average Convergence Divergence – MACD Definition

Moving Average Convergence Divergence (MACD) is defined as a trend-following momentum indicator
that shows the relationship between two moving averages of a security's price. more

Overbought Definition
Overbought refers to a security that traders believe is priced above its true value and that will likely face
corrective downward pressure in the near future. more

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