🎯 In 30 seconds: A relative strength line divides a stock’s price by a benchmark’s price. When the line rises, the stock is doing better than the benchmark, whether both are rising or falling. Comparing a stock with its sector and the sector with the market shows where the strength comes from. Research found that stocks with strong returns over the past 3 to 12 months tended to keep outperforming for a while, before costs. A rising RS line still loses money when everything falls, and the choice of benchmark and data can change the picture.
Not the same as RSI
The names are confusing. The Relative Strength Index (RSI) in Momentum oscillators compares a stock with its own past. Relative strength in this chapter compares a stock with something else, such as an index, a sector fund or a rival company.
Building the RS line
Divide the stock’s close by the benchmark’s close for each bar. The raw numbers are awkward, so most charts rescale the line to start at 100.
Worked example. A hypothetical stock, NARV, rises from $50 to $55, a 10% gain. Over the same weeks the index rises from 4,000 to 4,200, a 5% gain.
- Start ratio: 50 / 4,000 = 0.012500
- End ratio: 55 / 4,200 = 0.013095
- Change in the RS line: 1.10 / 1.05 minus 1 = 4.76%
Rescaled to start at 100, the RS line ends near 104.8. The line rose by 4.76%, slightly less than the 5-point gap between the two returns. Ratios compound, so the gap and the RS change only match for small moves.
Four ways an RS line can move
| Stock | Index | RS line | What it means for an owner |
|---|---|---|---|
| +10% | +5% | +4.8% | Making money and beating the market |
| +10% | +15% | minus 4.3% | Making money but lagging |
| minus 5% | minus 10% | +5.6% | Losing money, but less than the market |
| minus 10% | +5% | minus 14.3% | Losing money while the market gains |
The third row is the one people miss. A rising RS line says nothing about whether you made money. It only ranks the stock against its benchmark.
How people read it
- Direction and trend. Draw trendlines and swing points on the RS line just as you would on price. A series of higher highs and higher lows on the RS line marks steady leadership.
- RS leading price. Some traders watch for the RS line to reach a new high before price does. It suggests the stock held up well during the market’s last dip.
- RS against its own average. Plotting a moving average of the RS line, often around 50 or 200 days on daily data, turns “is it leading?” into a yes or no.
- Peers. Comparing two companies in the same business strips out the industry’s shared moves and shows which one investors are favoring.
Top down: market, sector, stock
A stock’s ratio to the market can be split into two parts: its ratio to its sector, and the sector’s ratio to the market. Multiply them and you get the stock’s ratio to the market. Checking both tells you whether a stock is strong because of its own business or because its whole group is in favor.
A common routine: first see which sectors have RS lines rising against the broad market, then look for stocks with RS lines rising against those sectors. The same approach works for countries, styles or asset classes.
What the research found
Jegadeesh and Titman (1993) studied US stocks and found that portfolios of recent winners, ranked by returns over the past 3 to 12 months, tended to outperform recent losers over the following months. This effect, usually called momentum, has been widely studied since. Two limits matter for an individual: the results were for diversified portfolios rather than single stocks, and trading costs and taxes eat into the edge, especially with frequent rebalancing. Relative strength can also reverse sharply when market leadership changes.
Where it misleads
- Dividends. Price-only ratios ignore dividends. A stock yielding 4% compared with an index yielding 1.5% will look about 2.5 points a year weaker than it really was. Check whether the data you use is adjusted for dividends.
- Benchmark choice. A small bank compared with a large-company index mixes up size, sector and stock effects. Use the closest fair benchmark you can find.
- Look-back window. Ranked over 3 months a stock may lead; over 12 months it may lag. Pick the window before you look, not after.
- Currency. A foreign stock priced in its home currency against a US index mixes currency moves into the ratio.
- Correlation. When a stock moves almost in step with its benchmark, its RS line barely changes and small wiggles look more meaningful than they are.
- A stock falls 8% while its index falls 20%. Is its RS line rising or falling, and did an owner make money? Answer: Rising (0.92 / 0.80 = 1.15, up 15%). The owner still lost 8%.
- A stock rises 20% and the index rises 20%. What happens to the RS line? Answer: It stays flat. The ratio is unchanged.
- Why might a high-dividend stock look weak on a price-only RS line? Answer: Its dividends are not counted, so part of its return is missing from the ratio.
- What did Jegadeesh and Titman find about past winners? Answer: Portfolios of stocks with the best returns over the prior 3 to 12 months tended to outperform past losers over the following months, before costs.
Sources
- Jegadeesh and Titman (1993), “Returns to Buying Winners and Selling Losers,” Journal of Finance
- John J. Murphy, Technical Analysis of the Financial Markets (1999), relative strength analysis
- Perry J. Kaufman, Trading Systems and Methods, relative strength and ranking methods
- Moneydesks Technical Analysis tool: relative strength vs another symbol, correlation, the Compare box and the Performance tab