Why Relative Strength Investing Produces Winners
The differences between relative strength and momentum investing are substantial yet many investors confuse them or even think they are identical. The same can be said for making investment decisions based solely on charts instead of comprehensive technical analysis.
Michael Carr defines his book, “Smarter Investing in Any Economy”, as the definitive guide to relative strength investing. Anyone wishing to learn about relative strength investing in depth and how it can be applied in various ways should read Carr’s book. However, the basic concept of is not simply to buy a stock (or ETF or Mutual Fund) that is moving up in the markets but to buy one whose strength is greater than the others.
Momentum investing is simply buying what is going up and selling when it goes down. This is the basis for most charting software and investment decisions based on looking at charts.
Relative Strength investing involves calculating the difference of the momentum of an ETF versus other ETFs and an index or benchmark like the S&P 500. While a chart can be created for any particular ticker symbol versus the benchmark, the important factor is how does each ETF relate to other ETFs? The answer shows the relative strength of each symbol to others within any particular group or universe of symbols.
In other words it’s like comparing horses at the Kentucky Derby. We know that every horse on the track can probably run faster than any other horse in the world; so each horse’s momentum is greater that my neighbors quarter horse out on the range. But picking the winner is just like buying based on Momentum alone. Yes, they are all winners, but only one is going to be The Winner, and only a few are going to bring home any prize money.
On the other hand, RS investing says that a particular horse’s speed is greater than the average horse and also is greater by a specific amount than every other horse on the track. And if you know the running speeds and durability factors of each horse (or each ticker symbol) you can bet on or buy the most likely winner.
This sounds complicated, but it doesn’t have to be mind boggling. There are formulas for calculating relative strength. In fact there are a variety of relative strength formulas and while you can tediously do this in a spreadsheet the easiest way is to use a software program that performs technical analysis that includes Alpha or simple Relative Strength Momentum.
A great way to use RS analysis is to combine it with momentum and selling rules so that you get the best of these worlds. A software program that offers all three aspects will include:
• Alpha or relative strength analysis
• A variety of charts
• Selling rules
• Ability to adjust the analysis to fit your buying goals and time frame
• A melding capability of the analysis, charts and selling rules
By blending momentum with RS investing you will be more likely to buy the winners and also more likely to sell and preserve profits while minimizing losses.