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InvestExplore.com Blog - Relative Strength and Volatility

Relative Strength and Volatility

March 27th, 2012

Relative Strength is an important technical metric that helps determine the price strength of a stock or an ETF in relation to either a pre-determined benchmark or an universe of stocks or ETFS. Relative strength is dependent on price action and it is measured over a period of time ranging anywhere from a few weeks to a year or more. A typical relative strength measure is between 1 and 99 with 1 being the weakest and 99 the strongest in relative performance for a given stock or ETF.

There is sufficient following for concepts and practices that follow relative strength in the technical analysis community and our own experience has also been confirming this. While relative strength as a concept is valuable problems can arise when investors or traders try to apply it.

Investors who haven't used or experienced relative strength in action over a period of time can easily be whipsawed often times in the application of the concept in actual trading. Investors may want to keep in mind that during certain phases of both bull and bear markets, high relative strength stocks or ETFS can be somewhat volatile as well. This volatility, if not understood properly, can lead to trading losses.

In the early stage of the bull market, stocks that are displaying improving relative strength characteristics usually perform very well. At some point these strong stocks log very high RS values nearing 99. At this stage the phase of the bull market also changes as it becomes more mature. At this stage some investors begin questioning valuation while others continue to join the momentum. Typically in this phase, high relative strength stocks experience volatility and corrections are bound to be sharp and severe. Investors entering the market purely on the basis of relative strength during this phase can be whipsawed and this can result in tremendous frustration.

We think it will be valuable for investors to also use another indicator along with relative strength to track the strength of price action at a much closer level to detect near term weakness.

For our research we have developed our own indicator called the BIR Rating which often helps us track the strength of price action on a weekly basis using a different approach. This BIR Rating's value can range between -100 and +100. When high relative strength stocks or ETFS begin logging weak BIR Rating values over a specific time period it usually alerts us to a possibility of consolidation.

Good Luck and Happy Trading!


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