Measuring and Using Relative Strength

John Biesboer

January 13, 2012

Relative Strength, sometimes called comparative Relative Strength, can measure the relationship between two securities, between a security and an index, or between two indexes. This does not refer to the popular indicator called Relative Strength Index. The RSI measures the performance of a security or index against itself by producing a normalized measurement of “up closes” versus “down closes” across a chosen time period.

Comparative Relative Strength is used in futures markets in inter-market situations, say comparing European wheat prices to Chicago corn prices as a spread or a ratio. We also see intra-market calendar spreads, another form of measuring Relative Strength, used as common hedging and trading tools.

A very useful way to apply RS is to compare a single security to an index by dividing the security price by the index level. This type of comparison then gives us an idea of the strength of that security compared to the index, indicating relative outperformance, if the RS is rising, or underperformance, if the RS is falling, of that security against an overall market or market sector.

Below, we have a chart of the Dow Industrial Index and with it a chart of the Relative Strength of a large US manufacturing company, here labeled “MFFG”. Beginning in early 2011 the Relative Strength of MFFG is decreasing while the Dow is in an uptrend.

Looking at a chart of the price of MFFG in the lower panel, we indeed see weakness in its actual price starting about the same time. In this case, the Relative Strength is acting as an early confirmation that we may be in a downtrend in the price of MFFG, rather than just a choppy phase that will soon continue higher along with the overall Dow Industrial level. The continued weakness in the Relative Strength could be an indication of the continued weakness in the price of MFFG moving forward.

In many situations, Relative Strength can be used along with the chart of the actual price performance of a security to help make entry or exit decisions.

About the Author

John Biesboer is a Senior Technical Account Manager at TelventDTN. He is a member of the Market Technicians Association and is working on completing requirements for the Chartered Market Technician designation. His office is in Chicago.

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