Skip to content Skip to footer

Relative Strength

What it is and how to apply to financial markets

What is Relative Strength?

The definition of relative strength, but one basic way, is a momentum technique that compares a particular stock or financial instrument, as compared to that of the overall corresponding market. This is a fundamental tool that is used to calculate which investments are stronger/weaker performers.

A basic example is using the Dow Industrial Average as a way to show relative strength based upon the above definition. Suppose on a given day, the Dow, comprised of 30 stocks is down 2% on that day. Assuming this example is a “broad-based” selloff, all 30 Dow Stocks would be negative or in the red. But per se IBM, a Dow stock, is positive on the day. IBM is showing relative strength as compared to the index and most likely its peers. Granted there might be material news or even abnormal volume but IBM is still displaying relative strength.

How to apply relative strength principles to Forex and the Equity markets:

Understand there are different formulas that can calculate a Relative Strength Index, or RSI, that many traders use. These formulas are either a standard query or a lot of times a formula that any individual can create usually predicated on price action, trend, and volume. For the Forex and/or equity examples, I will demonstrate the basic theory and not any empirical formula(s) to simplify things.

When it comes to the Forex markets and determining the relative strength of a currency, it’s important to identify whether that currency, say the Dollar, is in a bullish or bearish trend against a basket of other currencies. Note, regardless of market opinion, put your ego aside. A trend is still a trend. If the Dollar is in an upward trend against a basket of currencies, we can apply this towards buying/selling the currency against the Dollar.

The equities markets are a little more complex due to the fact that there are other mitigating factors that we can use to identify relative strength. The most important is once again, identifying trends. Not only when it comes to any indexes but for that particular stock and even so, the group that the stock trades in. A further example to follow.


Recognizing/Applying Relative Strength in Trending Market(s):

First of all, a trader using even the basic relative strength principles should be aware that volatility, especially in shorter time frames, will affect the RSI in a more dramatic or even false fashion. But for this example, we will use the United States Banking Sector. A current sector in a bullish uptrend but one prone to geopolitical news as well as fundamental news in the sector. Say Citigroup (C), Bank of America (BAC), Morgan Stanley (MS), Goldman Sachs (GS) are weak on a day when the market is down modestly. Remembering the market and sector are in bullish uptrends but Wells Fargo (WFC) is unchanged or even up on the day. WFC is therefore showing relative strength against the market and group and many, myself included, would consider buying WFC because if the market were to rally, showing its current uptrend and obvious strength would likely rally as well.

Say the market did rally. The banks, in their uptrend, more than likely would rally as well. But say the weakest acting stock in that group, Bank of America, did not rally or didn’t really “as much as it should” and you decided to buy the laggard in the group. More times than not, Bank of America would not bounce or rally as much as their stronger acting peers. If the market were in a downtrend and banks were in a weak trend, then conversely, Bank of America would be on my list to look at as a possible short… assuming there were price action and volume.

Pitfalls to using Relative Strength:

With over 20 years of trading experience at a high level, I have found that many traders apply the relative strength principles without regard to recognizing a clear trend in the market they are dealing with and even the entity to which one chooses to “play”.

Example: Assuming the US Financial stocks, some mentioned above, are in the clear uptrend and appreciating with the corresponding US indices. If you have 9 out of 10 Bank stocks that are positive and there will be some up greater than others but Bank of America (BAC) is down on the day. Assuming there is no material news on BAC and IS showing relative weakness to the group, many traders decide to short BAC because it is blatantly showing relative weakness. But most traders lose on that trade because if the market rallies and bank stocks are outperforming, than most likely BAC would rally or “squeeze” as well, thus continuing its current uptrend. The way to play the above scenario would be to buy the leader’s and not short the laggard due to the current uptrend in markets and financial stocks… although I would note that BAC was weak in a strong market and would keep on the radar for a weak financial day.

In closing, within a group of stocks or any other investments, some perform better than others. Using RSI indicators and the Relative Strength theory recognizes these differences in performances and thus allowing the trader an additional edge to one’s investment strategy.


Follow us on Twitter

Tradeview Ltd. is not a portfolio manager or an investment advisor. This Market Report is for informational purposes only. Any statements made or opinions voiced in this Market Report do not constitute investment advice. The Tradeview Ltd. Market Report does not constitute a solicitation to buy or sell in the financial markets. Although the information contained in the Market Report comes from trusted sources, Tradeview Ltd. is not responsible for guaranteeing the accuracy, timeliness, completeness, or fitness of such sources. Tradeview Ltd. shall not be responsible for and disclaims all liability for any losses which may be suffered from access and use of the contents of the Tradeview Ltd. Market Report. Trading any financial instrument on margin, using leverage or otherwise involves considerable risk. Therefore, before deciding to participate in any style of trading, you should carefully consider your investment objectives, level of experience and risk appetite. Most importantly, do not invest money you cannot afford to lose. Consulting with your investment counselor, attorney, accountant or other professional upon whom you rely for guidance as to the appropriateness of an investment in any style of trading is recommended.

Tradeview Ltd.

Is licensed to carry on securities investment business and is regulated by the Cayman Islands Monetary Authority (CIMA) as a full securities broker-dealer. Tradeview conducts business pursuant to the Cayman Islands Securities Investment Business Law (SIBL) and its activities fall under the direct supervision of the Investments and Securities Division of CIMA.
Headquarters: 5th Floor Anderson Square, 64 Shedden Road, Georgetown, Grand Cayman, Cayman Islands KY1-1002, BWI.

Tradeview Asia Ltd.

Is licensed and regulated by the Labuan Financial Services Authority (FSA) as a Money Broker, registration number LL15870 licensed to facilitate transactions in foreign exchange pursuant to Labuan Financial Services and Securities Act 2010, the Labuan Companies Act 1990 and the Labuan Business Activity Tax Act 1990.
Headquarters: International Business Financial Centre at Office 5, Jamie Business Center I, Unit F10, First Floor, Paragon Labuan, Jalan Mustapha, 87000 Labuan F.T.

Tradeview Europe Ltd.

Is licensed as a Category 2 Investment Service Company and is regulated by the Malta Financial Services Authority (MFSA). The Malta Financial Services Authority (MFSA) is the single regulator for financial services in Malta. MFSA is a fully autonomous public institution and reports to Parliament on an annual basis. The MFSA is a member of the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA) and the International Organization of Securities Commissions (IOSCO) and is a signatory of the Multilateral Memorandum of Understanding with other European regulatory Institutions. Tradeview is authorized to provide financial services across multiple asset classes and is passported in the EU/EEA under MiFID II (EU Markets in Financial Instruments Directive).
Headquarters: 157 Archbishops Street, Valletta VLT Malta 1440.

Tradeview Financial Markets S.A.C Global

Is authorized to conduct business pursuant to and in compliance with the General Law of Companies (LGS) promulgated by the government of Peru. Tradeview Financial Markets S.A.C is registered with the National Superintendence of Public Registries (SUNARP), company number 13089531. Tradeview Financial Markets S.A.C provides financial services in selected OTC derivative markets in compliance with all applicable government regulations.
Headquarters: Los Mirtos 239 Urb. San Eugenio, Lince, Lima, Perú.