Practical ways to implement relative strength investing

Smarter Investing In Any Economy: The definitive guide to relative strength investing by Michael Carr is a book from which one can learn some practical aspects of relative strength investing. Here is what I learnt from the book:

When you use a relative strength strategy for buying and selling stocks, you need a clear plan:

  • Deciding which stocks to buy means you need to decide which are strongest on a relative basis compared to all other stocks.
  • The first thing to do is choose a group of stocks from which you will make your selections. Broad market indices like S&P 500, NSE 500, BSE 500 are good choices.
  • The next thing to do is look at percentage change over a certain period( say one month, three months, six months, twelve months)
  • Then rank these stocks from the highest positive percentage change to the lowest.
  • Then you could buy a certain number of stocks( lets say the top 25%)
  • You recalculate the relative strength daily, weekly, monthly.
  • You could sell stocks if they fall below the top 25%. This would increase turnover and increase transaction costs or you could say that you will sell if the stock goes below a certain percentage( say the top 50% of the stocks ranked by relative strength).
  • You could also have a stop. Say a trailing stop of 25% from purchase price or a 3 ATR stop.
  • You could also say that you will buy only if the stock trades above its long term moving average( say 200 day moving average)
  • You can use ETFs, index funds, sector funds or stocks. If you use stocks it is probably wise to use some sort of fundamental screen as well( Screen 1, Screen 2)

There are many methods of calculating relative strength. I have listed them below:

1. Calculating RS as differences: This cannot be used in real life as different stocks are at different prices. You can use this method only if all the stocks started at the same price.

2. Calculating RS as a normalised rate of change

3. Applying RS over time: Here you can graph the rate of change(ROC) as an oscillator and buy if it is above 0 and sell if it is below 0. Or you can plot it against a moving average and buy when it goes above the moving average and sell when it goes below the moving average. This system would be profitable over the long run but there would be a lot of whipsaws.

4. RS ratio formulas: See these figures-1, 2, 3. The first two are similar to calculating RS as a normalised ROC. In figure three you can make buy and sell decisions based on trend line analysis. However this is subjective and is not recommended for most people.

5. Point and figure analysis can also be used with relative strength. Double-top/bottoms( above or below previous column) and triple top/bottom (above or below previous two columns) and trend lines can be used

6. Back-weighted rate of change. Another formula for the same.

7. Front weighted rate of change

8. Price to moving average ratios: Formula 1. Formula 2.

9. Ratios of multiple moving averages. Formula. Example.

10. RS as an average of different time periods: Formula 1. Formula 2.

11. Alpha and beta: Read this paper

12. Combing RS with technical indicators: Momemtum of comparative strength(MoCS)-formula, example

13. Combining RS and Price-Cycle Position: Formula

14. Accounting for risk.You can modify the formula by dividing by standard deviation Formula. This can be used with any other formula as well.

By using the principles and the formulas one can create a relative strength strategy to invest and trade.

 

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6 thoughts on “Practical ways to implement relative strength investing

    • Venkata Sreekanth Sampath says:

      I read it from a public library. If you can read it for free somewhere, that would be the best. Then you can decide whether it is really worth a buy. I have not bought the book and the post contains a summary of the most important things in the book.

      • AKbar says:

        Thanks for your reply.
        Where do you live and which library has these kinds of book.
        From where I live there are no places around where I could even rent such books for some amount of cash.

  1. AKbar says:

    Sorry, just came one more thought in my mind. You must be aware of the Investor Business Daily, they post Relative Strength for stocks, which is between 0-100. Do you have any idea how is that calculated (like in Investor Business Daily)

    • Venkata Sreekanth Sampath says:

      If a stock has a relative strength of 100, it means it is the best performing stock of the group.
      So, if you take a group of 30 stocks and tabulate their gains over say 6 months, the stock with the highest return is 100 and then you go down till the last stock is 0.
      Relative strength is just momentum investing.
      In IBD, they track a huge number of stocks and give relative strength for them in the manner above.

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