Finding big movers using Relative Strength

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Introduction:


Imagine you're at the racetrack, trying to pick a winning horse to bet on. Just like in the financial market where you have numerous investment options, at the racetrack, there are several horses competing in each race. Now, let's say you have two horses to select from, Horse A is consistently leading the pack and showing impressive speed compared to the other horses. Meanwhile, Horse B is struggling to keep up with its competitors and lagging behind. In this scenario, if you had to choose which horse to bet on, logic would dictate that you're more likely to place your bet on Horse A, the one that's performing better than its counterparts. Even though both horses offer potential opportunities to win, you'd naturally lean towards the horse where you see a stronger contender.


Similarly, in the financial market, investors face a multitude of investment options, ranging from various sectors and within those sectors various stocks. With so many choices, it can be difficult to decide where to allocate your funds.

Just as you'd choose to bet on the horse that's leading the pack, investors tend to prefer stock that is performing better compared to others in the market. In technical terms we can say particular stock is demonstrating strong relative strength compared to its benchmark indices or its peers or its competitors within the same sector. This approach allows them to maximize their chances of achieving positive returns and navigating the complexities of the financial markets with greater confidence.

What is Relative Strength & Why its important:


Technical Definition of Relative Strength is “Relative strength is a concept used in financial markets to compare the performance of one asset or investment against another. It helps investors assess how well one investment is doing relative to another similar investment or benchmark over a specific period of time.”

Simply put, relative strength measures the performance of one asset compared to another over a specific period. It helps investors identify which assets are performing better relative to others in the same market or sector. This information is invaluable because it allows investors to make informed decisions about where to allocate their capital for optimal returns.


Now, let's delve into why relative strength matters so much:

  1. Identifying Strong Performers: Relative strength helps investors pinpoint assets that are outperforming their peers. By focusing on these strong performers, investors can potentially capitalize on upward momentum and maximize profits.
  2. Spotting Trends: By analyzing relative strength trends, investors can identify broader market trends.
  3. Sector Analysis: Relative strength is not just about comparing individual stocks. It's also used to assess the strength of entire sectors relative to each other. This allows investors to allocate their resources to sectors that are showing the most promise. For example, if metal sector consistently exhibits strong relative strength compared to other sectors, it may indicate a bullish trend in metal sector.
  4. Stock Selection within Sectors: Within a sector, not all stocks perform equally. Relative strength analysis helps investors identify the strongest stocks within a sector, enabling them to focus on those with the most potential for growth. For example, say we shortlisted metal sector for investment purpose, using RS we can find the strong stock within the metal sector.
  5. Comparison with Indices: Investors often compare the relative strength of assets to relevant market indices. This provides a benchmark for performance and helps investors gauge whether a particular asset is outperforming or underperforming the broader market. For example, if we compare performance of HDFC Bank with nifty index, its consistently underperforming nifty 50 index.


RS is different from RSI:


It's important to note that relative strength (RS) is distinct from the Relative Strength Index (RSI), which is a momentum oscillator used to measure the speed and change of price movements. While both RS and RSI involve the concept of relative strength, they serve different purposes and are used in different ways in financial analysis. RS compares the performance of assets or sectors against its peer or benchmark, while RSI measures momentum and potential overbought or oversold conditions in a single asset's price.

Methods of identifying Relative Strength:

There are many ways to compare relative strength of the stocks against its peer or broader market indices. lets understand one by one

1. Based on Price Performance:


Comparing the price performance of one stock to another over a specific time period can show relative strength. If one stock consistently does better than its peer or benchmark, it might suggest stronger relative strength.


Take this example where we've looked at the performance of HDFC Bank and SBI compared to the Nifty index across three different timeframes. By analyzing the percentage returns of both stocks, it's evident that SBI is relatively stronger than HDFC Bank across all the timeframes.



Under this method we can also plot returns on graph and carry out the visual analysis of returns charts.


In attached graph we have compared returns of HDFC Bank [Orange line] & SBI [Blue Line]. Where HDFC Bank price is drifting sideways and SBI price in strong uptrend. This way we can simplify the task of stock selection.



2. Relative Strength Comparison (RSC):


RSC line is a method used to identify relative strength in the financial markets. This technique involves plotting a line on a chart that compares the price performance of one asset to another, typically against a benchmark index or another asset in the same category.


Here's how it works:

  1. Selecting Assets: First, you choose the assets you want to compare. This could be two individual stocks, a stock and an index, or any other combination of assets.
  2. Plotting the RSC Line: Next, you plot the Relative Strength Comparison line on a chart. This line shows the ratio of the price of one asset divided by the price of another asset over time.
  3. Interpreting the RSC Line: When the RSC line is rising, it indicates that the first asset is outperforming the second asset or benchmark. Conversely, when the RSC line is falling, it suggests that the first asset is underperforming relative to the second asset or benchmark.
  4. Identifying Relative Strength: By observing the direction and slope of the RSC line, investors can quickly identify which asset is exhibiting relative strength compared to the other. This information can be valuable for making investment decisions, such as choosing which stock to buy or determining which sector is performing better than others.


Overall, RSC lines provide a visual representation of relative strength, allowing investors to easily compare the performance of different assets and identify potential opportunities in the financial markets. Lets understand concept with one example


Take a look at the chart for Piramal Enterprise (PEL) with the Relative Strength Comparison (RSC) indicator. The RSC line at the bottom shows how PEL is doing compared to the Nifty Index. Since October 2023, the RSC line has been going down, indicating that PEL is weaker compared to the Nifty. After December 2023, the RSC line dropped below zero, showing even more underperformance.

If you're using TradingView, you can find the RSC indicator by searching for "Relative Strength Comparison (RSC) Indicator Signals by chuckination." In the indicator settings, you can choose a benchmark index or stock and select a look-back period[100 for swing trades]. For a stock to be considered bullish, the RSC line should be above zero and moving upwards.

For a deeper analysis, you can study historical multibaggers and take note of how their RSC movements correlate with their performance.

We will cover RSC indicator in detail in our indicator section.

3. Market Breadth Analysis:


Market breadth analysis is indeed a valuable method for identifying the relative strength of a sector within the financial markets.


Assessing the number of stocks within a particular sector that are advancing versus declining can provide clues about relative strength of the sector. A higher proportion of advancing stocks may indicate stronger overall sector strength. A consistently rising advance-decline line confirms the relative strength of the sector. It indicates that the majority of stocks within the sector are performing well, which can be a positive sign for investors considering investments in that sector.


This is very powerful tool during intraday. Market breadth analysis can be useful over longer periods, especially when assessing the health of a sector's performance over weeks, months, or even years.

4. Price Range Analysis:


Investors can also analyze the price range of an asset relative to its peers. If an asset consistently trades at the higher end of its range compared to others, it may indicate relative strength.


say stock is trading close to its 30 day high as compared to stocks trading close to its 30 day low - former stocks is relatively stronger as compared later.


based on the attached chart, the Nifty Metal index is trading near its 30-day high, while the Nifty IT index is close to its 30-day low. As a short-term trader, I would prefer to go long on the Metal index or a metal stock within this sector rather than an IT stock.

Similarly Long term traders can look at 52 week high and low for identifying relative position of the stock within 52 week range.

5. Using Indicators:


While relative strength charts are popular, investors also use various technical indicators to assess relative strength. These may include moving averages, momentum indicators, or volume analysis.


Let's explore how to do this using the example of moving average indicators, specifically the 20-day, 50-day, and 200-day moving averages

  • If the current price is above all three moving averages (20-day, 50-day, and 200-day), and all 3 moving averages are trending upwards, it indicates strong upward momentum and potential relative strength.
  • If the current price is above the long-term moving averages (50-day and 200-day) but below the short-term moving average (20-day), it suggests moderate strength but with a potential shift in trend.
  • If the current price is below all three moving averages, it indicates potential weakness and relative underperformance.

Thus by comparing Moving average location of different stocks can find their relative strength.


Lets take one example:

In next pic we can see 4 stock charts: BEL, Hind Copper, HDFC Bank, PEL.

in first two charts, BEL and Hindustan Copper are consistently above all three moving averages, indicating a strong bullish trend. Moreover, they show robust recovery after each correction.

On the other hand, HDFC Bank[third chart] struggles to stay above all three moving averages, making it challenging to identify a clear trend. Lastly, PEL [4th chart] remains below all moving averages, signaling a bearish trend.

By using indicators or mathematical formulas for identifying relative strength , we can simplify and streamline the selection process, making it easier to pick one stock out of the four based on its strength relative to others.


Have made chartink scanner based on above conditions, which will filter out all weak stocks and you will be left with all bullish stocks. Once we have shortlisted our stocks can use any momentum signal [say super trend] for entry into any of this stocks.

Scanner Link: https://chartink.com/screener/rs-sma-3

Case Studies:

1. Nifty Metal Index:

Let's take a look at this example. We're comparing the Nifty metal index with the Nifty index. RSC line plotted on chart shows relative performance of Nifty metal index against Nifty 50 Index.

If we focus on the period from February to June 2023, we can see that the RSC (Relative Strength Comparison) line was below 0. This indicates that the metal index was underperforming compared to the Nifty index. Looking at the price chart, we notice that the metal index remained sideways throughout this whole period.

In July 2023, something changed. The RSC line crossed the zero line, signaling that the metal index had begun to outperform the Nifty. As a result, you can see that the Metal index surged from 6400 to 8900. This shows us that identifying the breakout level can help us recognize when a sector starts to outperform.

So, the first step is understanding which sectors are performing well, and then finding the bullish stocks within those sectors. This approach helps us identify the best possible stocks from the better-performing sectors.

2. IT sector in 2020 Fall

Let's look at an example from 2020. We all remember how the market dropped during that year, but there was a quick recovery. The IT sector was one of the first to bounce back from the 2020 fall, and it made a remarkable move.

Starting from February 2020, the RSC (Relative Strength Comparison) of the IT sector against the Nifty index crossed the zero line. This signaled that there was a possibility the IT sector might start to outperform the Nifty index. In March 2020, when the market fell, the IT index also fell, but its drop was less compared to the overall market. Interestingly, IT was the first sector to recover to its all-time high. It not only reached its previous high but also soared to 27000 levels from low of 11200. Throughout this period, the RSC line remained above the 0 line.

So, by following this method, we could have identified the best-performing and worst-performing sectors of 2020. This approach would have allowed us to participate in the recovery with better sectors and better stocks.

Conclusion:

In conclusion, conducting a relative strength study can provide valuable insights into identifying strong stocks in the market. Throughout this blog, we've explored various methods and techniques to assess relative strength, such as comparing price performance against benchmarks, analyzing moving averages, and scrutinizing sector rotation patterns. By employing these methods, traders and investors can pinpoint stocks that consistently outperform their peers, showcasing robust price momentum and potential for further growth. Remember, relative strength analysis serves as a powerful tool in making informed investment decisions, guiding towards opportunities with the greatest potential for success in the ever-changing landscape of the stock market.


Disclaimer:

1.        Objective of this documents is share knowledge on Method of Analysis and not the strategy.

2.        Before using for trading please understand the method and precautions to be taken while using.

3.        A great strategy is useless without proper discipline and even mediocre strategy can do the trick with strong discipline.

4.        Observe 100s of historical charts using this method or in combination of other indicators and see how it works. Then try to form the rules for entry / exit and stop loss.



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