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.
In ChartMill, 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: