Relative Strength.
How Tough Is Your Stock?

Momentum investors love this indicator. Relative Strength is simply taking the percentage price change of a stock over the past year and comparing it to other stocks. This stock can compared to stocks within the same industry or the entire index.

If Google has an RS of 90, it has preformed better percentage wise than 90% of other stocks in the market.

There is also another indicator that shares a similar name. It's called the Relative Strength Index (RSI). It identifies overbought & oversold situations. As opposed to finding the best performing stock of the lot.....it finds entry and exit positions in the short term. We'll discuss both.

Relative Strength Index (RSI). RSI compares a stock’s recent gains to its losses and plots the calculations on a scale of 1 to 100. This indicator looks for an overbought & oversold situation.

RSI is considered oversold when the line has crossed below 30, formed a bottom and now heads up crossing above 30. A stock in this situation is considered a buy. The stock price has fallen on relatively high volume over a short period of time. Other investors consider the stock undervalued and buying theoretically commences.

When the RSI line crosses above 70, forms a peak and heads back down below 70, you have yourself a sell. Also known as overbought.

Goldman Sachs. After the credit mess of late summer '07, GS shares took a beating. I have no idea why. It's not like a money-making machine such as Goldman Sachs had finally met it's match. Anyway, smart traders jumped in and picked up the undervalued Goldman Sachs.

Middle of August, RSI drops below 30 and starts its way back up. The trend continues as does the price. That was a nice climb. Imagine if you had call options.

Beginning of October the RSI takes an overbought position. Around October 10th the RSI line breaks below 70 and it becomes profit taking time on Wall Street. To confirm the RSI, the MACD also begins a bearish reading.

The RSI is not a primary indicator. It should be used in conjunction with the MACD or other technicals. In a sideways market it won’t help much.

This indicator may also warn of a reversal in trend through a divergence. Divergences occur between the price action and the RSI line. If the stock price is in a downtrend while the RSI is in an upward, a reversal is likely to happen. This signals that the stock is under accumulation and things will pick up. The reverse is true for a downtrend.

Lets dicuss the other Relative Strength indicator that has nothing to do with it's cousin of the same name.

And now for something completely different. As described above, Relative Strength compares a stock’s price gain against all other stocks in the market. The better your gain, the higher you rank.

The use of this indicator is simple. But you can get creative with it as you’ll see. If a stock has a Relative Strength of 85, it is performing better than 85% of the stocks in the market. This stock obviously is under or has been under accumulation. So, it makes since to buy it and pray the trend continues. End of story. Quantum physics not needed.

Here are a couple of conditions to be aware of:

• This stock may continue to rise for months or even over a year. Expect your occasional minor corrections, but the trend is your friend.

• However, how do you know you’re not at the peak? Just becuse you have a RS of 90 doesn't mean you'll keep going. William O'Neil from IBD says:

Most successful stocks make their climb through a series of bases. You’ll have a nice climb, some consolidation, then a climb. Most investors don’t notice the first base. By the time the stock has climbed and formed base 2 & 3, the word is out. The buyers have already settled in

Most stocks don’t make it past base 4. Wall Street likes it that way. As the last investors pile in, the selling begins. A base breaks down when the price breaks below the low point of that base.

If the stock picks up speed again, start from zero in regards to base counting.

• If you have a watch list of stocks with high relative strength, review that list after a few down days in the market. The stocks that closed up during that period are the ones that will take off during the next upturn. Those are the tough guys. And Wall Street has those on their list as well.

The two places I use to find high Relative Strength stocks are from are www.Investors.com and MSN Money MSN Money lets you find stocks that have high RS value within the past 3, 6 or 12 months.

Sometimes I’ll experiment with the stock screener. I’ll screen for stocks that have had RS value over 80 in the past 3 months in additon to having RS value less than 60 for the past 12 months. I’ll set 200,000 for the average daily traded shares.

What does this concoction find? Stocks that recently began trending strong. I use this to eliminate stocks that have been trending for a long time and may be reaching a peak. This is not a bullet-proof formula. I suggest trying a few variations and see what you come up with.

I like using Relative Strength because it simply finds stocks that are trending strong. Like all indicators it does not foresee the future.

But if the past looks good, I’ll take it.

Netflix. On October 23rd 2007 it had a 12 month RS value of 50 and a 3 month RS value of 96.

Maybe I should have set my 3 month RS to a lower value. I could've picked up the nice trend that began end of September. Nothing like hindsight. Time to move on with my life.

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