Relative Strength is a term we use in stocks, ETFs, as well as in many other financial instruments. As regards stocks, the term means that the strength of a stock is compared to some other stock, to the sector the stock belongs to, or even to the general index of the stock exchange, or any other index we believe it is useful.
Let’s give an example of relative strength. Let’s take the stock of a car manufacturer, Tesla Inc for example. We can compare this stock with:
Some other car maker
In the chart below, the Relative Strength of Tesla compared to General Motors is shown at the bottom of the chart. The Relative Strength is the red line whereas the blue line is the Relative Strength’s 20-day moving average.
Fig. 1: We can see above the Relative Strength of TESLA Inc. - the red line at the bottom pan- as compared to General Motors Co. TESLA is outperforming General Motors since December 2019.
2. The general Automobiles Industry
Fig.2: We can see above the Relative Strength of TESLA Inc. - the red line at the bottom pan- as compared to the Automobile Industry $GJUSAU. TESLA is outperforming Automobiles throughout most of the period shown in the chart.
3. An Index like the S&P500
Fig.3: We can see above the Relative Strength of TESLA Inc. as compared to the S&P500 $SPX. TESLA is outperforming $SOX throughout most of the period shown in the chart.
At an even wider level, we can measure the relative strength of the stock exchanges’ Index in relation to another Stock Exchange.
At this point, we must point out that Relative Strength has no relationship with the Relative Strength Index, as the latter refers to an isolated security, while the former is always measured in relation to something else.
Moreover, it is possible that a stock falls but its Relative Strength rises. This can happen if the stock falls at a slower rate than the index against which we measure its relative strength. The opposite can also be true: a stock can go up, while its relative strength falls. In this case, the stock goes up at a slower rate than the benchmark Index.
As it may be evident from above, what is more important for us is the fluctuations of Relative Strength and not its absolute value. It is quite common that Relative Strength fluctuates between some lower and some higher values, which in this case can act as support and resistance levels. What is more, we can add in Relative Strength charts moving averages, trendlines etc.
Those who include relative strength in their strategy can be divided into two categories:
The first category is usually the momentum traders who believe that stocks with high Relative Strength will continue to move up faster for some time. It is those who buy high and sell higher as they believe that a stock with strong momentum will keep going up.
The second category has the opposite opinion. They believe that stocks with low Relative Strength are in some way oversold and therefore at some point this trend will reverse, so that they reach the level of “normal” price for Relative Strength. The traders who follow this strategy have usually a longer trading time frame.
For most traders, Relative Strength charts can give additional information that can help in trading decisions. For example, before buying a stock, we can use as an additional filter the requirement that the stock’s Relative Strength is rising and it’s above its 20-day moving average. Another strategy we can use is to buy stocks from a sector whose Relative Strength goes up in relation to the Index.