Relative strength is one of our primary tools as Technicians, but we’re not talking about the Relative Strength Index.
Instead, we’re talking about the relative performance of one security relative to another. By identifying those assets that are outperforming or underperforming, we know which have institutional support and which do not. Institutions are looking for relative strength and momentum
Much like the Relative Strength Index, we utilize this tool as a confirmation tool for price. When relative strength diverges from price, we can identify potential turning points in the trend.
Let’s take a look at a few examples.
First, we’ve got the Nifty Financial Services index relative to the Nifty 500, which has been trending higher for the last 3.5-years. Because of its strong relative performance, we knew that pullbacks on an absolute basis were likely a buying opportunity as opposed to a major shift in trend. That continues to be the case today.
Click on chart to enlarge view.
Meanwhile, the Nifty PSU Bank Index has been in a clear downtrend relative to the Nifty 500. As a result, we’ve been suspect of its bounces on an absolute basis and so far that’s been the right call as it approaches its 2016 lows. This is a great example of something we want to either be avoiding or selling short from any sort of intermediate or long-term perspective.
As I mentioned at the top of the post, relative strength can also be used as a tool to identify turning points. In November 2019 we looked at Nifty Pharma as its relative performance met our downside price target and began to turn higher. This, combined with a failed breakdown and bullish momentum divergence on an absolute basis made us turn bullish on the sector as a whole with great success so far.
In terms of tools in our Technical Analysis toolbelt, relative strength is up there in the most important category with price and momentum. If you’re not familiar with it, it’s definitely worth reading up on and considering as an addition to your process.
Thanks for reading and let us know if you have any questions!