Relative Strength Analysis

The process of relative strength analysis involves comparing the price performance of a security to a benchmark or a group of similar securities. The benchmark can be an index, such as the S&P 500, or another asset class, such as bonds or commodities. The goal is to determine whether the security in question is outperforming or underperforming the benchmark over a specific time period.

To conduct relative strength analysis, traders or investors typically use technical analysis tools, such as charts, graphs, and indicators. They compare the price movement, trading volume, and other technical factors of the security being analyzed to those of the benchmark.

If the price of the security being analyzed is rising at a faster rate than the benchmark, it suggests that the security has strong relative strength and is outperforming. Conversely, if the security's price is falling at a faster rate than the benchmark, it indicates weak relative strength and underperformance.

Relative strength analysis can be applied to individual stocks, sectors, or even entire markets. It is often used in conjunction with other technical and fundamental analysis techniques to confirm investment decisions. For example, a trader may use relative strength analysis to identify stocks that are outperforming their peers and then use fundamental analysis to examine the financial health and prospects of those stocks before investing.

By using relative strength analysis, traders and investors can gain insights into market trends and potentially profit from them. It helps identify opportunities to invest in assets that have a higher probability of continuing their positive performance, while avoiding or shorting assets that are likely to continue their negative performance.

However, it is important to note that relative strength analysis is just one tool among many, and it should not be relied upon as the sole basis for making investment decisions. It is also worth mentioning that past performance is not always indicative of future results, so it is essential to conduct thorough analysis and consider other factors before making investment decisions.

What Is Relative Strength Analysis?

To perform relative strength analysis, you would typically follow these steps:

1. Select a benchmark or a group of peers: Start by choosing a benchmark or a group of similar assets against which you want to compare the performance of your target asset. This benchmark could be an index, such as the S&P 500, or a group of stocks in the same industry or sector.

2. Gather performance data: Collect the necessary performance data for both the target asset and the benchmark or peers over a specific period. This data could include daily, weekly, or monthly price or return data.

3. Calculate relative strength: Calculate the relative strength of the target asset by dividing its performance by the performance of the benchmark or peers. For example, if the target asset gained 10% over the chosen period and the benchmark gained 5%, the relative strength would be 2 (10% / 5%). A relative strength above 1 indicates outperformance, while a relative strength below 1 indicates underperformance.

4. Analyze the results: Examine the relative strength values to identify patterns and trends. Look for assets that consistently show high or low relative strength compared to the benchmark or peers. This analysis can help you identify assets that may be worth investing in or avoiding.

It's important to keep in mind that relative strength analysis is just one tool among many that you can use to make investment decisions. It should be used in conjunction with other methods of analysis and should not be the sole basis for making investment decisions. Additionally, relative strength analysis is backward-looking and may not always predict future performance accurately.

How to Find Securities With Relative Strength

1. Relative Strength Index (RSI): The RSI is a commonly used technical indicator that measures the strength and speed of a security's price movement. It oscillates between 0 and 100, with levels above 70 indicating overbought conditions and levels below 30 indicating oversold conditions. By comparing the RSI of different securities, you can identify those that are showing relatively stronger performance.

2. Moving Averages: Moving averages can help identify trends and gauge the strength of a security's price movement. Comparing the moving average of one security with another can highlight those with stronger uptrends or greater bullish momentum.

3. Price Performance: A simple yet effective way to identify securities with relative strength is by analyzing their price performance over a specific time period. Look for securities that have consistently outperformed their peers or benchmark indices.

4. Relative Strength Ranking: This method involves ranking securities based on their price performance relative to their peers or a benchmark index. A higher ranking indicates stronger relative performance.

5. Momentum Indicators: Other popular momentum indicators like MACD (Moving Average Convergence Divergence) or Stochastic Oscillator can also help identify securities with relative strength. These indicators consider both price and volume movements to identify trends and potential buying or selling opportunities.

6. Relative Strength Factors: Some investors analyze fundamental factors like earnings growth rate, revenue growth rate, or other financial metrics to determine the relative strength of securities. By comparing these factors across different securities, you can identify those with stronger fundamental performance.

Remember that these methods should be used in combination with other forms of analysis and should not be considered standalone indicators of relative strength. It is important to consider the overall market conditions, sector performance, and other factors that may impact a security's performance.

I agree with your analysis. Chart analysis, ratio analysis, relative strength rankings, stock screeners, and fundamental analysis are all valuable tools for identifying securities with relative strength. Each method provides a different perspective and can help confirm or refute the findings of the other methods. By using multiple approaches, investors can minimize the risk of making decisions based on inaccurate or incomplete information. It is also important to regularly review and update analysis as market conditions and company dynamics change over time

Relative Strength Examples

Your examples demonstrate the concept of relative strength analysis quite effectively. In each case, the mentioned companies exhibited strong performance compared to their industry peers, resulting in outperformance of their stock prices.

Amazon, for example, benefited from the accelerated shift towards online retail during the pandemic, which propelled its revenue and earnings growth. This relative strength compared to traditional brick-and-mortar retailers allowed Amazon's stock price to outperform.

Similarly, Zoom Video Communications experienced a surge in demand for its video conferencing platform as remote work and online learning became the norm. This relative strength compared to other communication and technology stocks led to significant outperformance.

Tesla's relative strength in the electric vehicle industry was driven by factors such as strong sales growth, innovative technology, and increasing adoption of sustainable transportation. These factors contributed to Tesla's stock price outperforming its competitors.

Moderna's stock price rally can be attributed to its development and successful rollout of the COVID-19 vaccine. The company demonstrated relative strength compared to other pharmaceutical stocks, as its vaccine became a crucial component in the global fight against the pandemic.

Lastly, Shopify witnessed robust growth as businesses increasingly embraced e-commerce during the pandemic. The company's relative strength in the e-commerce and technology sector allowed it to outperform its peers.

While these examples showcase the potential benefits of identifying securities with strong relative strength, it is important to conduct comprehensive research and analysis before making any investment decisions. Additionally, market conditions and industry dynamics can change rapidly, emphasizing the crucial need for ongoing evaluation and monitoring of investments.

Pros and Cons of Relative Strength Analysis

Yes, that is correct. Relative strength analysis should be used in conjunction with other forms of analysis to make well-informed investment decisions. It is important to consider a variety of factors such as fundamental analysis, market trends, and risk management strategies. Additionally, investors should regularly review and update their relative strength analysis to ensure it remains relevant and effective in changing market conditions.

The Bottom Line

Exactly! Relative strength analysis is just one tool in the investor's toolbox and should be used in conjunction with other forms of analysis and research to make informed investment decisions. It's crucial to consider a range of factors, including fundamental analysis, market conditions, and risk tolerance, to build a well-rounded investment strategy. By doing thorough research and applying different analysis methods, investors can increase their chances of making successful investment decisions.