What is relative strength
Relative strength is a way of measuring how a stock is performing compared to something else, usually a broad market index like the S&P 500. Instead of focusing only on whether a stock is going up or down, relative strength asks a more important question: is this stock outperforming or underperforming the market? A stock can be rising in price, but if the market is rising faster, it is actually showing relative weakness. Conversely, a stock can be flat or even down slightly while still displaying relative strength if it’s holding up better than the broader market. Relative strength helps identify where money is flowing and which stocks are truly leading.
Why should we use relative strength
Using relative strength gives traders and investors a clear edge because it lets us focus on stocks that are actually outperforming the market. Rather than chasing price alone, we look at performance in context. A stock making new highs might seem strong, but if the broader market is moving higher faster, it’s relatively weak and that can be a warning sign. By concentrating on stocks showing true relative strength, we align ourselves with where money is flowing, which often precedes sustained moves. This approach also helps us avoid weak stocks that may temporarily rise on hype but fail to keep pace with the market. Over time, consistently trading with relative strength increases the odds of being on the winning side of trends and reduces the risk of buying into underperformers. It’s a straightforward, discipline based tool that provides a measurable advantage in decision making.
What does relative strength look like
Relative strength becomes clear when we compare a stock’s price action to the broader market, such as the S&P 500 (SPY). Let’s look at an example with points A and B. At point A, the stock makes a low while SPY also makes a low. Later, at point B, the stock forms a higher low meaning it doesn’t drop as much as it did before while SPY makes a lower low, declining further. This divergence is a classic signal of relative strength. Even though the stock may still be moving down slightly, it is holding up better than the market. The higher low in the stock compared to the lower low in SPY shows that buyers are stepping in sooner and stronger, while the broader market is weaker. Identifying patterns like this consistently allows traders to spot leaders and laggards before price alone makes it obvious.
How the Ratio Line Reveals Relative Strength and Weakness
Another effective way to measure relative strength is by using a ratio line of a stock versus the SPY. A ratio line is simply the stock’s price divided by SPY, and it gives us a clear visual of performance relative to the overall market. When the ratio line is rising, it tells us that the stock is outperforming SPY, it’s gaining ground faster than the broader market. You can see this clearly on the left side of the chart, where the ratio line is trending higher alongside rising prices.
However, take a look at point A. Not only did the ratio line begin to trend lower, but it also broke its recent low before the stock itself did. This is an important observation because it signals that the stock is starting to underperform relative to the market, acting as a sort of leading indicator. The ratio line is giving us an early warning before price confirms the weakness. Sure enough, the stock eventually continued lower, confirming the underperformance that the ratio line had already highlighted. Using ratio lines in this way provides a real edge by showing relative strength or weakness ahead of price action.
Final Takeaway
Relative strength is a simple but powerful concept that can dramatically improve how you view the market. By comparing stocks to the broader market, you gain clarity on where true strength and weakness exist, rather than relying on price alone. Whether you’re analyzing higher lows, divergences, or ratio lines versus SPY, relative strength helps you identify leaders early and avoid laggards. Over time, consistently focusing on relative strength can provide a real edge by aligning you with institutional money flow. It won’t eliminate losses, but it does stack the odds in your favor. In the long run, trading and investing become less about prediction and more about consistently following strength.
If you want to see more examples of relative strength in action, you can find more analysis at
No comments:
Post a Comment