College Level

Introduction
to Technical
Analysis RELATIVE STRENGTH

Lecture 9 Definition of Relative Strength

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Objectives
Relative Strength Trading Model
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Relative Strength Discipline

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Using Relative Strength to Determine Future Market Leadership

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Relative Strength Charts

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This lecture series is produced by

the Market Technicians Association
Educational Foundation
based on the detailed class notes of
Charles D. Kirkpatrick II, CMT
Copyright 2007. All rights are reserved.

Market
Technicians Reading
A s s o c i at i o n Master Textbook
E d u c at i o n a l Technical Analysis: The Complete Resource for Financial Market Technicians
Charles D. Kirkpatrick and Julie R. Dahlquist
F o u n d at i o n
Chapters 21; pp. 509-535
Identifying and funding
educational programs in the field Additional Reading
of Technical Analysis since 1993 Techncial Analysis of the Financial Markets
Murphy, John, pp 422-426, 450-451
MTA Educational Foundation
Post Office Box 425127 Technical Analysis, reprinted from the Financial Analysts Handbook,
Cambridge, MA 02142-5127 Shaw, Alan, Chapter 11
617/253-8959 Fax: 617/452-2199
[email protected] www.mtaef.org
 The following is the intellectual property of Alan R. Shaw which is, in part, an updated
version of a chapter written for the Financial Analysts Handbook, and updated material
for a future manuscript.

Definition of Relative Strength

One of the oldest approaches of technical analysis, and still one of the
most widely used, is Relative Strength (RS). As the term implies, action
of a stock, or a group of stocks, is often compared to the market as a whole,
so that it can be determined whether or not the stock or the group is acting
better than, or worse than the market in general.
Relative Strength may also be employed as an inter-market relationship.
For example, lets say a global portfolio manager may have an interest
in knowing whether the Japanese market looks more attractive than the
U.S. Aside from making a value judgement, a relative strength trend
would help answer the question from a price perspective. One might be
interested in knowing the relationship between gold and bonds, or oil and
gold. Dividing one by the other will result in a trending statistic whereby
the numerator would be doing better if an uptrend in the RS is in force
while the denominator would be acting better if a downtrend in RS was
underway.
Making money in a bull market is not a difficult task. If the general
market trend is up, we agree that a dart thrown at the stock table should
result in the choice of a winner. In these days of competitive performance
on the professional level, relative performance has taken on an even more
important aspect. Professional portfolio managers must show the ability to
outperform the market, particularly if they looking for a year-end bonus. On
the other hand, funds could be invested in an index fund that is guaranteed
to emulate the market, with consequently little or no management fee. Such
passive portfolio management has grown extensively in recent years for
at least a portion of pension assets. Some academic studies have supported
the view of difficulty in outperforming the market on a consistent basis,
and some active managers indeed have found it difficult to outperform a
major bull market trend.
Many technical analysts often apply relative strength analysis first to
the markets groups, believing that a strong group is a prerequisite to
picking a strong stock. Our research supports this view. While one can, of
course, pick a good-acting stock from a broad RS stock screen, its a lot
easier, or potentially more profitable, if the trend of the groups behavior
is supportive.

College Level Introduction to Technical Analysis Relative Strength Lecture 9, page 

 Relative Strength Trading Discipline
Many different mathematical computations may be used to calculate
relative strength, but the simplest (and most utilized) is when the daily (
or weekly) close of as stock (or group) is divided by a market average or
index, the later being most often the S&P 500. And then the result of this
exercise might be related to a specific time period to result in a ratio. If
the simple RS plot, or ratio, moves up or down over a period of time, the
trend will indicate whether or not the stock or group is acting better than,
or worse than, the general market trend. A stock that is moving laterally
while the market is trending lower will, by definition, possess a strong
relative strength curve. A stock that is moving laterally as the market moves
laterally will possess flat, or in-line relative strength trend.
Relative strength is an important technical tool, but like any other
technical discipline RS analysis should probably not be a sole application.
As an example, it should be noted that, without utilizing any other technical
discipline, one could find a stock topping out while maintaining a strong
relative strength curve or it could bottom out while relative strength
appears poor. While these two characteristics would more than likely be an
infrequent development, it is nevertheless advisable to input other technical
guide lines, like trend analysis, support/resistance analysis, etc.

Using Relative Strength to Determine Future Market Leadership

Many times the technical analyst will use relative strength to determine
future market leadership, or the potential loss of leadership. Groups that act
well in the tail end of a bear market, often emerge as the new bull markets
leaders. Leaders in a bull market may show signs of losing that status if
relative strength divergence begins to profile a mature trend. Simply said,
if the absolute price index of a group goes on to make a new bull trend high
without the relative numbers confirming, this divergence could well be a
harbinger that a change in the groups price trend may not be far off.

Relative Strength Charts

Almost all the commercial charting services include a relative strength
plot on their graphs. But some of the presentations are practically useless
due to the space limitation that translates into a scaling problem. Of the
two major daily bar chart services, the Trendline Charts presentation of
RS is plotted on a scale so small that it is very difficult to identify a trend
progression the RS plots essentially take on a flat profile. The Daily

College Level Introduction to Technical Analysis Relative Strength Lecture 9, page 

Chart 1 Graphs daily chart presentation is a bit better as more space is allocated
Price Trend versus Relative Strength
to illustrate the RS plot. The most popular weekly bar chart service, the
Mansfield charts, illustrate what they call a relative strength ratio, but like the
Trendline charts, its often quite difficult to determine an RS trend because
of a scaling problem. On the monthly bar chart front, the SRC Bluebook
illustrates a fairly usable RS plot that most often will provide an identifiable
trend progression to allow confirmation analysis to be applied.

Following are a number of illustrations of RS analysis and its applications.

Chart 2 The following notes should be applied to each illustration.
International Flavors & Fragrances
Chart 1 - Price Trend vs. Relative Strength. The most attractive stocks
have strong price action and relative strength. The least attractive
stocks have poor price action and relative strength. (The upper left
portion of the box in the strongest picture. The lower right is the
weakest.)

Chart 2 - International Flavors and Fragrances (IFF). Note price and

relative strength confirmed the upturn in 2002. However, relative
strength started faltering in 2003, then diverged negatively in 2005 and
Chart 3
International Game Technology again in 2007.

Chart 3 - International Game Technology (IGT). Price and relative

strength were in gear in 2000-2004 on the upside and in 2005-2006
during a correction. Relative strength started to diverge in early 2007.

Chart 4 - Edison International (EIX). Price and relative strength have

been in gear. Note, however, the new relative strength high in 2007
was just marginal. This could be the beginning of deterioration.

Chart 5 - International Paper (IP). The stock had several unsustained

Chart 4 advances in the second half of the 1990s, but relative strength was
Edison International
poor. Relative strength has been unfavorable since 2003.

Chart 5
International Paper

College Level Introduction to Technical Analysis Relative Strength Lecture 9, page 

Chart 6 Chart 6 - Dow Jones U.S. Select Home Construction Index. Price action
DJ US Select Home Construction Index
and relative strength have been in gear. Momentum (MACD) gave
negative signals in 2005-2006.

Chart 7 - Dow Jones U.S. Electric Components & Equipment Index.

The 2002-2007 bull market in price is intact. Note the relative strength
deterioration starting in 2006.

Chart 8 - Dow Jones Wilshire U.S. Insurance Index. There has been a
bull market in price since 2003, but no relative strength confirmation.
Momentum (MACD) gave a series of sell signals during the bull
Chart 7 phase.
DJ US Electric Components & Electrical
Equipment Index
Chart 9 - There is a weekly plot of the Dow Jones U.S. Mining Index.
Price action and relative strength have been in gear throughout the bull
phase and during the 2006 correction. Note the extreme momentum
peak in 2006, suggesting a blowoff was in progress and the likelihood
of a bigger correction.

Chart 8
DJ Wilshire US Insurance Index

Chart 9
DJ US Mining Index

College Level Introduction to Technical Analysis Relative Strength Lecture 9, page 

Chart 10 Chart 10 - This is a weekly plot of the Dow Jones U.S. Food &
DJ US Food & Beverage Index
Beverage Index. Price and relative strength were briefly in gear in
2002, but the rest of the bull market has been subpar, resulting in
consistently poor relative strength.

Chart 11 - Dow Jones U.S. Oil & Gas Producers Index. Note the
continued confirmation of the price advance with relative strength and
the sustained strong upside momentum.

Chart 12 - Dow Jones Wilshire U.S. Telecommunications Index. Price

and relative strength were in gear in the 2000-2002 bear market. Price
Chart 11
bottomed out in 2003, but relative strength did not confirm until 2007.
DJ US Oil & Gas Producers Index
Chart 13 - Dow Jones Industrial Average. The relative strength line is a
ratio of capital goods stocks to consumer goods stocks. The ratio tells
us to be overweight one or the other. The ratio told us to emphasize
capital goods in the late 1990s, consumer goods during the bear market
in 2000-2002, and then capital goods again in 2006-2007.

Chart 12
DJ Wilshire US Telecommunications Index

Chart 13
Dow Jones Industrial Average

College Level Introduction to Technical Analysis Relative Strength Lecture 9, page