Relative Strength: The Most Underrated Indicator

Louis Sykes
February 23, 2023

The most underrated element of technical analysis has to be relative strength.

It's impossible to outperform your benchmark if you own assets that are underperforming.

Much of this work is grounded in the overarching notion that asset prices trend while volatility mean-reverts.

But humans behave as if it's the opposite.

Relative strength is merely denominating prices in a different asset than the native currency. Like price trends, relative strength also exhibits a tendency to trend, rather than mean-revert.

So, what does that mean?

It means that if an asset has outperformed its benchmark, there's a higher probability of it continuing to outperform rather than for it to begin underperforming.

We all know this is true, whether or not we like to admit it.

But simply buying the strongest assets feels like cheating. So, in our insidious craving for complexity, we treat relative strength as if random and under a constant state of flux. This way, we unconsciously trick ourselves into believing we have to employ a greater deal of intricacy that is necessary.

People fighting trends is as old as time and certainly isn't isolated to financial markets.

Think about it: The majority of people will maintain apathetic attitudes to new styles, ways of life, food, and cultures. We are hardwired to dislike change; it's uncomfortable and it comes with a high degree of uncertainty.

This week, I moved back to Auckland, and I've been homesick.

I'm not a city person in the best of times, not to mention that there are new people, surroundings, and a totally different environment here I'm not used to.

But I'm aware that these are my emotions speaking, rather than any rational thoughts.

The same can be said for those who spend their days fighting trends when they put money on the line.

When a new sector is showing leadership, our first instinct isn't to follow price, but to relish in the comfort of our recency bias.

Don't believe me?

Look at how long it took investors to finally warm to energy stocks; people dislike change and remain stubbornly stuck in growth stocks at the same time that sector dispersions were at decade highs.

In the best examples, identifying leadership is easy.

That small patch of green while everything else is deep in the red?

Keep your eye on it, because chances are it'll be the strongest when everything else stops sliding.

We cannot reiterate this enough.

Relative strength.

No matter how much love we give it, it'll always be underrated.

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Thanks for reading, and please let us know if you have any questions!

Allstarcharts Team

 

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