Chart Advisor: Visualizing Relative Strength

By Alex Cole

Visualizing Relative Strength

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Visualizing Relative Strength

I would argue that the concept of relative strength is one of the most important in technical analysis. Of course, we need to clarify.  I am talking about studying the ratio of one asset to another in order to find outperformance.  We are not talking about RSI (Relative Strength Index), which while powerful, is not the same thing. Not only can we compare one security to another, but we can look for leadership within any universe.  For example, relative strength analysis can help an investor find securities that are driving returns in a portfolio as well as find those that are hurting performance and should perhaps be removed.  Alternatively, an investor could use relative strength analysis to understand which commodities deserve his attention.  Are metals performing well, or should we invest in oil?  In this article, we’ll discuss relative strength and apply it to a study of the equity sectors.

Courtesy of StockCharts

The chart above is a simple line chart of the ratio of XLU (utilities) to SPY (S&P 500). Relative strength itself is a simple concept.  When looking at a chart of a ratio, we can say that the numerator is the outperforming security if the line is rising.  Therefore, we know that over the past few months, a position in XLU would have added alpha to a portfolio over simply holding the broader index.  

How do we include this analysis as chartists in our daily workflow to get an idea of which sectors are primed to out-perform?  We can of course cycle through 10 different charts and make note of the slope of each line.  If we wanted to accelerate the process we could add all of the relative strength lines for the sectors to one chart. 

Courtesy of StockCharts

The chart above is a simple line chart of the ratio of XLU (utilities) to SPY (S&P 500). Relative strength itself is a simple concept.  When looking at a chart of a ratio, we can say that the numerator is the outperforming security if the line is rising.  Therefore, we know that over the past few months, a position in XLU would have added alpha to a portfolio over simply holding the broader index.  

How do we include this analysis as chartists in our daily workflow to get an idea of which sectors are primed to out-perform?  We can of course cycle through 10 different charts and make note of the slope of each line.  If we wanted to accelerate the process we could add all of the relative strength lines for the sectors to one chart. 

Courtesy of TrendSpider

The chart above does just that.  Although I have worked with many clients that endeavor to work in charts like this, I don’t think it would be hard to convince anyone that an awful lot of skill (or luck) is required in order to quickly identify the out-performing sectors in the S&P 500 from this image. What else can we do to streamline our efforts?

Courtesy of StockCharts

We can take advantage of platform functionality to create a multi chart layout that will allow us to separate all of the sector ratios into mini charts (see above chart).  This may help, but still, it can be difficult to quickly see which sectors are relatively out-performing the larger index.  On close inspection, it looks like the 4th (XLK) and 8th (XLU) are in rising trends.

How can we address these issues with GoNoGo Charts? First, let’s go back to the relative strength chart of XLU/SPY and instead of eyeballing the trend, we’ll apply the GoNOGo trend methodology. 

Courtesy of StockCharts

Now we can see clearly the trend of the relative strength line.  In mid March, after a first higher low, GoNoGo Trend flagged a new “Go”, and the last few months have shown a series of higher highs and higher lows.  Seeing this relative “Go” trend in the utilities index could have led to an investor seeking opportunities in this space.

How could we apply this methodology across all sectors? Can we do it in a way that avoids the pitfalls of trying to put all lines in one panel or creating 10 small and arguably unreadable charts? We use the GoNoGo Sector RelMap.

Courtesy of StockCharts

This chart applies the GoNoGo Trend methodology to all of the sector relative strength ratios but simply colors individual panels without worrying about traditional price movements. This allows us to watch the rotation between sectors as it happens, and in a way that allows us to focus our attention on the out-performing sectors.  We can quickly see that at the moment, there are 2 sectors that are in relative “Go” trends to the larger index; technology (XLK, top panel) and Utilities (XLU, 2nd from bottom).  We don’t have to subjectively eyeball it, GoNoGo Trend tells us using a weight of the evidence approach. Given our discussion so far, it is no surprise that the utilities sector is in a relative “Go” trend, but hopefully it is clear that using different visualizations, such as the GoNoGo Sector RelMap, these conclusions become more easily reachable. 

These GoNoGo RelMaps can be created for any universe.  We have used RelMaps for commodities, currencies, countries, cryptocurrencies and many others. It is good practice to include relative analysis in a technical approach.

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Originally posted 31st May 2024