A Relative Strength Investing Strategy

Relative strength, also known as “price persistence”, is a measure used by many technical analysts to help them understand the direction and momentum of a stock. The term relative strength refers to how a stock is performing relative to something else, typically an index, an industry or another stock. A stock’s relative strength is expressed as a percentage. For example, if a stock has a relative strength of 80, it has outperformed 80 % of the other stocks over specified period of time.

Measuring Relative Strength

Relative strength is calculated by dividing the price performance of the stock of interest by the price performance of what it is being measured (eg an index, industry or another stock) against for the same time period. If it is stronger, then it is said to have relative strength. If it is weaker, then it is said to have relative weakness. In analyzing relative strength, the investor will often produce a chart that illustrates how the stock has traded relative to that index.

While many technical analysts view high relative strength as an indication of future increases, others may see the stock as overpriced.

Relative Strength and Momentum Investing

Momentum investors seek to identify stocks with high relative strength with the belief that the prices of these stocks are likely to continue increasing. Momentum investors see this strategy as more effective than buying stocks with falling prices. Momentum investors will most often review multiple time periods to assess relative price strength.

Momentum investors can point to historical data to support this strategy as, over the very long-term (spanning multiple decades) no stock selection strategy has out-performed relative strength. For them, the key is in buying and holding the strongest stocks and replace those stocks for which momentum has turned.

An Alternative View of Relative Strength

Alternatively, many technical investors will tell you that the key to understanding relative strength is to understand that stocks and their sectors tend to operate in cycles. Because of this, it may not be a good idea to purchase a stock that is sitting at its peak as that stock may be currently over-bought.

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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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