January 1, 2010, Newsletter Issue #138: What is Relative Strength?
Tip of the Week
The traditional focus of the relative strength indicator is the comparison of a stock to an underlying index like the S&P 500 Index (SPX), creating a single line showing relative performance. This comparison is usually the performance of a key stock versus the entire market. We think of the relative strength almost like a funnel of money flow. As the stock is outperforming a particular index, money is flowing more heavily toward that equity than that of the broader market. Likewise, if the stock is underperforming in comparison to an index, the equity has money flowing at a slower rate into the equity versus the general market. A stock that displays improving relative strength versus the market or a corresponding sector index may be on the verge of an aggressive move to the upside. Conversely, a stock that begins to show weakness relative to the market or its peers may be poised for a breakdown.
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