Relative strength analysis is a powerful technique that helps traders identify which stocks are outperforming or underperforming the broader market. Rather than looking at a stock in isolation, relative strength compares its performance to a benchmark, revealing true market leaders and laggards.
What is Relative Strength?
Relative strength (RS) measures how a stock performs compared to another security, typically a market index like the S&P 500. It is not the same as RSI (Relative Strength Index), which measures momentum within a single security.
Key concept: A stock can go down in price but still have rising relative strength if it falls less than the market. Conversely, a stock can rise but show weak relative strength if the market rises faster.
Calculating Relative Strength
The basic relative strength ratio is simple to calculate:
- RS Ratio: Stock Price / Benchmark Price (e.g., S&P 500)
- RS Line: Plot this ratio over time
- RS Percentile: Rank stocks by their RS values
When the RS line is rising, the stock is outperforming the benchmark. When it is falling, the stock is underperforming.
Interpreting the RS Line
Rising RS Line
- Stock is outperforming the benchmark
- Strong buying interest relative to market
- Often indicates institutional accumulation
- Bullish signal for the stock
Falling RS Line
- Stock is underperforming the benchmark
- Weak demand relative to market
- May indicate distribution by institutions
- Bearish signal for the stock
Example: Interpreting Relative Strength
Suppose Stock XYZ gains 5% while the S&P 500 gains 8%.
Even though XYZ went up, its RS line would be falling because it underperformed the market.
This suggests XYZ has weak relative strength and may not be the best investment choice.
Trading Strategies Using Relative Strength
1. Buy Strong, Sell Weak
The classic relative strength strategy:
- Focus on stocks with rising RS lines
- Avoid or short stocks with falling RS lines
- Let the market tell you which stocks to own
- Works well in trending markets
2. Sector Rotation
Use relative strength to identify leading sectors:
- Compare sector ETFs to the S&P 500
- Rotate into sectors with rising RS
- Exit sectors with deteriorating RS
- Captures major market trends
3. RS Breakouts
Look for relative strength line breakouts:
- RS line breaking above a resistance level
- RS line making new highs before price
- Often precedes strong price moves
- Confirms bullish technical patterns
Warning: Mean Reversion Trap
Do not assume weak RS stocks will catch up. Stocks with poor relative strength often continue to underperform. This is why many traders prefer to buy strength rather than weakness.
RS Divergences
Bullish RS Divergence
- Price makes a lower low
- RS line makes a higher low
- Suggests underlying strength building
- May signal a trend reversal
Bearish RS Divergence
- Price makes a higher high
- RS line makes a lower high
- Warns of weakening momentum
- May precede a decline
Using RS Percentile Rankings
Many traders rank stocks by relative strength percentile:
- Top 20%: Market leaders worth considering
- Middle 60%: Average performers
- Bottom 20%: Laggards to avoid or short
Focus your long positions on stocks in the top percentiles for the best probability of outperformance.
Combining RS with Other Analysis
Relative strength works best when combined with:
- Price patterns: Breakouts with strong RS are more reliable
- Volume analysis: Rising RS with increasing volume confirms strength
- Moving averages: RS line above its moving average is bullish
- Fundamental analysis: Strong RS with good earnings is ideal
Limitations of Relative Strength
- Does not predict absolute returns
- Strong RS stocks can still decline in bear markets
- May lag during sharp sector rotations
- Historical RS does not guarantee future performance
Track Your Portfolio's Relative Strength
Pro Trader Dashboard helps you monitor how your holdings perform against market benchmarks.
Summary
Relative strength analysis helps traders identify which stocks are truly outperforming or underperforming the market. By focusing on stocks with rising relative strength lines, traders can position themselves in market leaders rather than laggards. Use RS in conjunction with price patterns, volume analysis, and fundamental data for the most complete picture of a stock's potential.
Learn more: Price Momentum Trading and Volume Momentum Analysis.