By: Bill Spencer — May 10, 2019
Last week we dove more deeply into this key idea of relative strength.
We brought to the fore the two meanings of the term. We said that...
Strong relative strength meant that an investment had outperformed another. It performed better, which could have meant it performed “not as badly.”
Weak relative strength meant that an investment underperformed another. It performs worse, which could have meant it performed “not as well.”
The key idea here is that relative strength is. well, relative.
We said a few weeks back that to calculate RS between any two investments -- two stocks... a stock versus an index... an index versus another index... or any two things, really...
That all you need to do is divide the change in the price of one on a particular day, by the change in the price of the other. Then chart your results. Keep in mind that, because of the way RS charts are made, you'll never see any absolute prices appear on the chart. You only see the result of the calculation.
There are two things to think about when looking at a relative strength chart:
Also, no RS chart can ever tell you if the prices of either of the two investments (that you're comparing) have gone up or gone down.
The chart only tells you if the performance of the one was strong or weak compared to the other.
Here's a 6-month price chart of NVIDIA (NVDA)...
(Click any image to enlarge)
And here's the S&P, our proxy for the wider market, over that same period...
They both look like typical line charts you see all the time. Lots of ups and lots of downs, some more dramatic than others. But how does the one compare to the other? It's not obvious is it?
Here's the RS chart (the "study") comparing NVDA and the S&P.
That chart look very much like the chart of NVDA, above. But it shows you, at a glance, how NVDA has performed relative to the market. Without an RS chart, you'd have to perform the calculations yourself and plot each point on your own chart.
Here's NVDA again. I've annotated two time periods.
From January 3, 2019 to April 8th, NVDA rose 49.85%. And from April 8th to Thursday, May 9th it fell 11.26%.
Let's look at the RS chart with those same two periods annotated.
Notice how, during a period when NVDA was knocking the cover off the ball -- gaining almost 50% -- the stock's RS measure versus the S&P only gained 25.7%. That's barely half as much.
When NVDA fell 11.26% its RS measure versus the S&P fell just 10.6% -- practically the same amount.
So you can see that RS charts (and RS studies in general) are an invaluable trading tool.
We'll have much more to say about all of this going forward.
Have a great weekend everybody!
Editor-in-Chief, True Market Insiders