Interesting Charts #4
Relative Strength
Not only is it important to ensure that the share you are holding is going up, but more important it must be outperforming the market as well. If not, there is an opportunity cost in continuing to hold the share. Technical Analysis presents us with a powerful indicator to assess this called Relative Strength, which compares the performance of any share with the market index.
Relative Strength is one of the most misunderstood indictators, perhaps because the term is often applied to other indicators that actually have nothing to do with Relative Strength. Most popular computer software packages don't even have Relative Strength as an indicator, which is beyond belief, because it is really one of the most important tools for any equity/share trader. Relative Strength is a single line chart where a rising line shows that the share is performing better than the index and a falling line shows that it is performing worse. You should hold the share whilst the R/S line is rising and switch out of it when the line starts to fall.
The charts below illustrate this
Kingfisher
The upper chart shows the price of FTSE 100 constituent, Kingfisher, which has been in a strong uptrend since July 1995. Anyone holding this share would have been pleased until they looked at the Relative Strength chart below. The chart shows that between July 1995 and February 1996, Kingfisher performed marginally better than the FTSE 100 index. Between February 1996 and July 1996, it outperformed the index by a considerable margin, but after July 1996 something changed. Although the share price continued to new highs, the R/S line started to fall, indicating that Kingfisher was no longer a star performer. This change in trend was the signal to switch out of Kingfisher into another share with a rising R/S line.
British Gas
The price chart of British Gas below, shows a declining price between June 1995 and November 1996. The Relative Strength Chart was also declining showing the BG was performing considerably worse than the market. Notice however, that in October 1996 the downtrend in the Relative Strength chart was broken indicating that BG was about to perform better than the market. A month later the BG downtrend came to an end. The share has continued to outperform the index ever since.
Relative should not be ignored. Within any market, some shares are rising and some are falling. Relative Strength helps you to identify the performers and can tell you when you should be switching.
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