Price Relative / Relative Strength
The Price Relative is used to gauge relative strength, which is important when it comes to stock selection. Many portfolio managers compare their performance to a benchmark, such as the S&P 500. Their goal is to outperform that benchmark. In order to achieve this goal, managers often look for stocks that are showing relative strength. Enter the Price Relative. The Price Relative rises when a stock shows relative strength and is outperforming its benchmark. Conversely, the Price Relative falls when a stock shows relative weakness and is underperforming its benchmark.
Stock Recommendations
There are a few ways to use the Price Relative. First, chartists can perform simple trend analysis to determine the direction of the Price Relative. This can be based on the actual trend, support/resistance breaks, moving averages or other indicators. Second, chartists can look for bullish and bearish divergences in relative strength to warn of a potential reversal in the stock price.
Trend Identification
Chartists can apply basic trend analysis or moving averages to determine the direction of the Price Relative. As with any price chart, the Price Relative is trending up when higher highs and higher lows form. Conversely, the Price Relative is trending down when lower lows and lower highs form. Chartists can also apply a moving average of choice. A long-term downtrend could be present when the Price Relative is trading below its 150-day SMA. Alternatively, a long-term uptrend could be present when the Price Relative is trading above its 150-day SMA.
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The chart above shows Hewlett-Packard (HPQ) with the Price Relative (HPQ:$SPX). A 15-day SMA was applied to both the HPQ price and the Price Relative. First, notice that the Price Relative broke resistance in mid-June to signal the start of an uptrend. Outperformance continued into December as the Price Relative traced out higher highs and higher lows. The Price Relative peaked in late December and formed a lower high in late February. The subsequent break below the 150-day SMA signaled the start of a downtrend and a period of underperformance.
Bullish/Bearish Divergences
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A bullish divergence in the Price Relative signals relative strength during a price decline. Stocks that hold up the best during a decline are often the leaders when the market turns around. The chart below shows Dupont (DD) with the Price Relative (DD:$SPX). Even though the stock declined from late April until early July, the Price Relative moved higher to signal relative strength during this decline. Dupont was holding up better than the overall market. The stock subsequently became a leader when the market reversed and started moving higher in July. Notice that the Price Relative and the stock both broke resistance in late July (blue lines).
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A bearish divergence in the Price Relative signals relative weakness during a price advance. Stocks that underperform on the way up often lead lower when the market reverses. The chart below shows Mastercard (MA) with the Price Relative (MA:$SPX). After a sharp decline in early February, the stock advanced to a new reaction high in late April. The Price Relative did not confirm and formed a significantly lower high for a bearish divergence. Also, notice that Price Relative was flat when the stock advanced from the second week of March until late April (blue lines). These signs of relative weakness on the way up foreshadowed a sharp decline in May.
Conclusion
Even though this article focused on using the Price Relative for stocks, the Price Relative can also be used for broad market analysis. The stock market can be broken down into nine sectors represented by the sector SPDRs. Chartists can maintain charts with Price Relatives for these nine sectors to determine the leaders and the laggards. The market is in offensive mode when the technology and consumer discretionary sectors lead. The market is in defensive mode when consumer staples, healthcare and utility sectors lead. Once the leading sectors have been determined, chartists can then look within these sectors to find the leading stocks. Sectors that show relative weakness can be avoided to help narrow the search. As with all indicators, it is important to use the Price Relative in conjunction with other technical analysis tools. Momentum oscillators and chart patterns can be used to confirm or refute relative strength or relative weakness.