Relative Strength
What is it and how to spot it
Relative Strength or RS by definition is a stock that is showing strength relative to an index. It is used to determine a stocks performance versus a benchmark, typically the S&P 500, but you can chose any benchmark you’d like. All of the best winning stocks have shown RS prior to and throughout their major moves.
Stocks showing relative strength can stick out like sore thumbs when the market is in a correction. Nicolas Darvas in his book “How I Made $2,000,000 in the Stock Market” said:
“I tried to detect those stocks that resisted the decline. I reasoned that if they could swim against the stream, they were the ones that would advance most rapidly when the current changed.”
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Like Darvas said, stocks showing RS are the ones you want to focus on as they tend to be the big winners when the market begins a new uptrend. There are a few different ways to spot relative strength, these are my favorites:
The stock makes a higher low while the indexes make a lower low
The stock recovers to new highs faster than the indexes after a correction
The stock closes up on the week or the day while the indexes are down significantly
Let’s take a look at some examples of each.
The stock makes a higher low while the indexes make a lower low
The following chart compares Netflix (NFLX) to the S&P500 at the end of 2008 into the beginning of 2009. Note how every time the S&P500 made a new low NFLX made a higher low and continued to rally.
Another example is Google (GOOGL) from that same time. GOOGL and the SPX both make a new low together, however as the market goes on to make another new low GOOGL makes a higher low.
The stock recovers to new highs faster than the indexes after a correction
Let’s look at Peloton (PTON) coming out of the 2020 Covid crash. You’ll notice as the S&P500 and PTON both rally, PTON makes a new high while the S&P is still well off it’s previous highs.
The stock closes up on the week or the day while the indexes are down significantly
Lastly, lets compare Celsius (CELH) to the S&P500 in 2022. While the markets had a bad week closing down over 4%, CELH managed to close the week up over 5% on increased volume (volume not pictured below).
It is important to be able to identify relative strength when using technical analysis. While you can’t buy on RS alone, it is a major characteristic of winning stocks and greatly increases the chances of success.
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