On Relative Strength

The Strongest of the Strongest

Relative Strength(RS) is a concept that is heavily used on the Chartmill.com site. We use different flavors of Relative Strength. This article is meant to clarify the different kinds of relative strength that exist and are used at Chartmill.com.

Lets start by clearing one potential confusion. The popular RSI (Relative Strength Indicator) has nothing to do with the kind of relative strength we will discuss here. The RSI is an indicator that can be calculated completely from the historical data of one single stock. The RSI compares average profit to average loss of the same stock over a certain period.

This immediately brings us to a key point of the Relative Strength we will discuss: The Relative Strength of a stock always involves a comparison with another stock or other stocks. It expresses the performance of a stock relative to another one or relative to a whole set of stocks. The ‘other stock’ is typically a market or sector index.

We will discuss to kinds of Relative Strength:

• A stock is compared with the market or sector index. This measures how the stock is doing compared to the market or sector.
• A stock is compared to a set of other stocks. The set of other stocks can be the complete set of stocks we know or for instance all stocks that belong to the same sector or industry.

For the first kind of Relative Strength we have indicators availabe in our charts. We will look at Dorsey & Mansfield Relative Strength.

The second kind of Relative Strength is used in our sector analysis tool and in our screener. Here, the Relative Strength is a single number between 0 and 100. This number expresses how much % of the other stocks are outperformed by the stock we are looking at: a stock with a relative strength of 80 outperforms 80% of the other stocks in the market or group.

1 Relative Strength Indicators

Relative Strength (Dorsey)

This indicator is available on our charts. This form or Relative Strength was described and used in the book “Point & Figure Charting” by Thomas Dorsey. Dorsey was using XO-charts, but one can also interprete it on a regular chart.

The formula for calculating the indicator is quite simple:

RSD= ( close / close_index ) * 100

The value of the indicator is calculated each day by dividing the price of the security by the price of the index. It is multiplied by 100 just to have some numbers that are more or less ‘reasonable’, but this doesn’t impact the behavior of the indicator.

It is easy to see that if this indicator rises the stock is outperforming the market and if it declines, the stock underperforms the market. The rising or declining is independent of the actual rise or decline of the stock itself. The Relative Strength only expresses how the stock performs relative to the market. It is perfectly possible for a rising stock to have a declining relative strength: if the market rises harder, the division will lead to smaller numbers each day.

Currently, you can not choose the index that is used to compare to. We always compare with the S&P 500 index and we use the ETF with ticker ‘SPY’ to do this. ( As a consequence: if you look at the Dorsey Relative Strength for SPY, it will always be 100 )

So what can we do with this indicator? Have a look at the following chart:

• First of all, you can just look at whether a stock is out- or underperforming the market. If its Relative Strength is rising, it is outperforming the market. ( As we see on this chart ).
• In Dorseys book, this form of Relative Strength is used to look for Relative Strength breakouts. As on the chart, you can draw support & resistance lines on the RS indicator chart. A breakout of the RS confirms that a stock starts outperforming the market. On our chart, we see that somewhere in the beginning of august we have both a price and a RS breakout. The price and volume breakouts are perhaps enough to act upon, but when this is accompanied by a RS breakout, you have confirmation that the stocks also outperforms the market.
• The same thing is applicable to sectors. You can analyse which sectors gain relative strength in the market. Similarly, you can also compare stocks to their sector index to see which stocks are strong in a certain group.

Relative Strength (Mansfield)

This variant of Relative Strength was heavily used in the book “Secrets For Profiting in Bull and Bear Markets’ by Stan Weinstein. Weinstein was using the indicator mainly on weekly charts. In our charts, the default value for the parameter is 52, which is also meant to be used in the weekly timeframe. The meaning of this parameter will become clear shortly.

The formulae of this indicator is a bit more difficult than the regular Dorsey RS, but it is worth understanding:

RSM = (( RSD(today) /sma(RSD(today), n)) - 1 ) * 100

Where:

• RSD = Relative Strength (Dorsey) ( see above …)
• SMA = Simple moving average over n days.

So, the Dorsey Relative Strength value is divided by its own n-day moving average and then one is subtracted. If we look at the daily timeframe and use 200 for n, this means:

• We get 0 if the RSD is exactly equal to its 200 day moving average.
• We get a negative number if the RSD is below its 200 day moving average.
• We get a positive number if the RSD is above its 200 day moving average.

Most Technical analysists are familiar with the stock price being above or below a certain Simple Moving Average. With Mansfields RS, the same applies: if the relative strength is above its moving average, positive values are seen, if it is below, we see negative values.

Usage:

• As with the regular ( Dorsey ) RS, you can use Mansfield RS to examine if a stock performs better than the market. Only the rising or decling of the indicator matters for this.
• Stan Weinstein used the inidcator only on weekly charts with 52 as the parameter value for n. He insisted that break outs out of a base had to go together with rising relative strength. The Mansfield RS needed to be rising an close to or above 0.
• This indicator has the advantage over the Dorsey RS that the values are below or above the 0 line. This allows us to screen for stocks with a MRS value above 0. When we see that the MRS is far above 0 and has been above 0 for some time, we have found a stock that outperforms the market heavily. We can buy this kind of stock when dips occur. We can use the ‘Monest Value Indicator’ to seach for dips.
• The chart shown above is SOITEC. We see that the Mansfield Relative Strength went above 0 somewhere end of march 2009. The Monest Value Indicator is shown to indicate where the buying oppurtunities were.

Relative Strength by Ranking

A second kind of relative strength is obtained when stock performance is compared with the performance of all other stocks and then ranking the stocks. This approach leads to a single number that expresses how much percent of the other stocks are outperformed by this stock: a stock with a Relative Strength of 88 outperforms 88% of all other stocks.

Relative Strength

At Chartmill.com, we assign a number for ‘Relative Strength(MRS)’ to each stock in our database. We calculate this number by comparing the performance of each stock in our database over the last year to the performance of all other stocks in the same period.

We do not just take the yearly performance directly but we divide the year into 4 quarters and add the performances of each quarter. Because we think the more recent performance is more important when you are looking for strong stocks, we add the performance of the last quarter twice. This means that the last quarter has more weigth in our performance metric:

So:

Metric = pQ1 + pQ2 + pQ3 + 2 x pQ4 ( where pQ1 means: absolute performance in Q1, e.g +12% )

When we have done this for each stock in our database, we will rank the stocks according to the metric. After ranking them, we can assign a value between 0 and 100 for each stock. The stock with the highest value for the metric will get value 100 because it outperforms all other stocks ( = 100% ) in our database. The second one only outperforms 7999 of 8000 stocks, so it will get a Relative Strength number of 99.99.

Our screener allows to filter on Relative Strength:

• On the ‘Technical’ tab, you can select the ‘Relative Strength’ filter and choose to view only stocks with a minimum or maximum Relative Strength (MRS)’ number. This will show you only the strongest or weakest stocks in the entire database.
• We also allow sorting by Relative Strength for each filter or combination of filters you select. This allows for instance to rank all ETFs or all Euronext stocks according to Relative Strength.