Relative strength analysis is a powerful technique that helps traders identify which stocks, sectors, or assets are outperforming or underperforming the broader market. By focusing on relative strength timing, you can concentrate your capital on the strongest performers and avoid weak ones. This guide will teach you how to use relative strength for better trade selection and timing.
What is Relative Strength?
Relative strength (RS) compares the performance of one security to another, typically a benchmark like the S&P 500. A stock with high relative strength is outperforming the market, while one with low relative strength is underperforming. This is different from the RSI indicator, which measures a stock's momentum against itself.
The core concept: In any market environment, some stocks will outperform and others will underperform. Relative strength helps you identify the leaders. Studies show that stocks with high relative strength tend to continue outperforming, making them better trading candidates.
Why Relative Strength Matters
- Focus on winners: Rather than bottom-fishing, trade stocks already showing strength
- Sector leadership: Identify which sectors are leading the market
- Risk reduction: Stocks with high RS tend to fall less during market corrections
- Trend confirmation: Rising RS confirms a stock's trend is genuine, not just market-driven
How to Calculate Relative Strength
The basic relative strength calculation is simple:
Relative Strength Calculation
RS = (Stock Price / Benchmark Price) x 100
- Plot this ratio over time to create an RS line
- A rising RS line means the stock is outperforming
- A falling RS line means the stock is underperforming
Relative Strength Timing Strategies
1. RS New High Strategy
One of the most powerful signals is when a stock's RS line makes a new high before or alongside the price.
- RS new high with price breakout = Strong buy signal
- Price at new high but RS lagging = Weaker signal, exercise caution
- RS new high before price = Leading indicator of potential breakout
RS New High Entry Example
Stock XYZ is consolidating near $50 while its RS line quietly makes a new high.
- This shows institutional accumulation (stock outperforming even while consolidating)
- When price breaks above $50, you have a high-probability entry
- Set stop loss below the consolidation low
2. RS Ranking Strategy
Rank all stocks by their relative strength and focus on the top performers.
- Calculate 6-month or 12-month relative performance vs. benchmark
- Rank stocks from highest to lowest RS
- Focus trading on stocks in the top 10-20% of RS rankings
- Avoid or short stocks in the bottom 10-20%
3. Sector Rotation Strategy
Use relative strength to identify which sectors are leading and rotate your exposure accordingly.
- Calculate RS for each sector ETF against the S&P 500
- Overweight sectors with rising RS
- Underweight or avoid sectors with falling RS
- Review and rotate monthly or quarterly
4. RS Breakout Strategy
Watch for the RS line breaking out of its own patterns or above key levels.
- RS line breaking above a downtrend line signals improving strength
- RS breaking above a consolidation range confirms leadership
- Use RS breakouts as confirmation for price breakout trades
Entry Timing with Relative Strength
Best Entry Conditions
- RS above its moving average: Shows stock is in relative uptrend
- RS making higher highs: Confirms sustained outperformance
- Price pulling back while RS holds up: Indicates accumulation during weakness
- RS breaking out alongside price: Dual confirmation of strength
Entry Timing Checklist
- RS line is trending higher
- Stock is outperforming its sector and the market
- Price is at or near a technical entry point (breakout, pullback to support)
- Volume confirms the move
Exit Timing with Relative Strength
Warning Signs to Watch
- RS divergence: Price makes new high but RS does not
- RS breakdown: RS falls below its moving average or trendline
- Sector weakness: The stock's sector RS starts declining
- Ranking drop: Stock falls out of the top RS rankings
Exit Rules
- Exit if RS falls below its 50-day moving average
- Exit if stock's RS ranking falls below a threshold (e.g., top 30%)
- Tighten stops when RS shows divergence from price
- Consider partial exits when RS momentum wanes
Building a Relative Strength System
- Define your universe: Decide which stocks or ETFs you will analyze
- Calculate RS rankings: Rank all securities by relative performance
- Set your criteria: Determine minimum RS ranking for consideration
- Monitor RS lines: Watch for breakouts, new highs, and divergences
- Time entries: Use technical analysis to pinpoint entry on RS leaders
- Manage positions: Exit when RS deteriorates
- Rotate regularly: Update rankings and rotate into new leaders
Pro tip: Many winning stocks show RS improvement before their price breaks out. By monitoring RS, you can identify potential winners early and be prepared when the price confirms with a breakout.
Common RS Timing Mistakes
- Ignoring RS divergences: When price rises but RS falls, trouble may be ahead
- Buying low RS stocks: Hoping for a turnaround often leads to losses
- Not comparing to the right benchmark: Use appropriate benchmarks for context
- Chasing after extended RS moves: Wait for pullbacks, not already extended leaders
- Neglecting sector RS: Individual stock RS can be misleading without sector context
Combining RS with Other Timing Methods
Relative strength works best when combined with other analysis:
- Technical patterns: Look for breakouts in high RS stocks
- Momentum indicators: Confirm RS with RSI or MACD
- Volume analysis: High RS with volume confirms institutional buying
- Market timing: Trade RS leaders when overall market is favorable
Track Your Relative Strength Trades
Pro Trader Dashboard helps you analyze which relative strength setups work best for your trading. See performance by RS ranking and improve your stock selection over time.
Summary
Relative strength timing is a proven method for identifying and trading market leaders. By focusing on stocks that are outperforming their benchmark, you align yourself with institutional money flow and increase your odds of success. Use RS rankings, RS line analysis, and sector rotation to time your entries and exits more effectively. Remember, the goal is to trade strength, not weakness.
Continue learning with our guides on momentum timing and sector rotation strategies.