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10/21/02  

Relative Strength- Using It To Enhance Trading Results

Momentum investing is directed at identifying stocks using strong relative stock price action vis a vis the S&P 500 or some other index or against an industry group. Changes in relative strength are extremely important. If a stock has underperformed for a long period, but then turns up against the SPX, it can signal a reversal and a long potential period of outperformance. 

Conversely, an outperforming stock, which shows short term relative price weakness can be indicating a top and trend reversal.

Relative strength can be calculated for any time period. Momentum investors should look at multiple time periods to assess relative price strength. For instance, a momentum investor would look at one year, six month, one month, one week and one-day relative strength. If this seems obsessive and overdone, and computer intensive, then choose another style of investing. 

In essence, we look for crossovers where increases or decreases in relative price action signal a move in one direction or another. A momentum investor will use trendlines of relative price strength to signal breakouts, breakdowns, and reversals.   

Traders, for instance, can use this tactic for day trading. Let's say the SPX is lock limit down and at support, but you notice a stock is up at the top of its day range, when SPX hits its nadir. Let's assume further that the SPX is oversold and in an area of strong support. Generally, stocks that are outperforming at the bottom, will lead the market up as it bounces.

Also, if markets are essentially in a bull configuration, they will hit their lows of the day between 10:30 AM and 10:50 AM and 2:30 PM and 2:50 PM. If you get a confluence of markets hitting trading lows but in support, with lock limit down (which restricts program selling), your outperforming stocks for the day, week, and month will lead the market going out to the close.  The bounce can be very strong and rewarding in a matter of minutes. 

Anybody looking at these techniques should study the charts, examine their emotional state, and probably return to "buy and hold". However, those with the disposition, and the charting capabilities, and a small allocation of their investment dollars to trading, should take a closer look. 

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