Relative Strength

The RSI is a single-security indicator which measures "overbought/oversold"conditions of that security where RS compares two different securitiesin order to facilitate a choice.

RS is often referred to as Comparative Relative Strength orRelative Strength Comparative etc.

Relative Rotation Graphs are based on this Comparative RelativeStrength concept.

The formula to calculate Relative Strength is simple:

RS = Price of security A / Price of security B

The outcome of this formula is a (RS) line that usually is plottedin combination with the price chart of security A.

The interpretation of this Relative Strength line or "RawRelative Strength" as I often call it is very straight forward.

When the RS line moves up the Consumer Staples sector is outperformingthe broader market and should be "overweight" in portfolios.

When the RS line is moving down the Consumer Staples sector isunder performing the broader market and should be "underweight".

"JdK RS-Ratio", this is a proprietary indicatorthat uses a normalization algorithm which takes into account notonly the comparison against the benchmark but also the comparisonto all other elements in the universe. The result is a line thatoscillates around the 100-level, where values above 100 indicate a positivetrend in the RS-line and vice versa. This indicator enables "ranking"of a universe and basically answers the question: "Whatare your best five stocks/sectors/....etc."

JdK RS-Momentum line is a normalized measure of the Rate of Changeof the JdK RS-Ratio line.

Momentum line leads the Ratio line. When the RS-Momentum linecrosses above the 100-level a low has been formed in the RS-Ratio line(see vertical dashed green line) which started to move up. And viceversa, when the RS-Momentum line crosses below the 100-level a tophas been set in the RS-Ratio line which then has started to move down.

The construction of Relative Rotation Graphs is based on a scatterplot.

The RRG takes two inputs.

The center point of the plot (100,100) is the base or the benchmarkagainst which all elements in the plot are measured.

This means that in the top right-hand quadrant, the Leadingquadrant, items will show up that are exhibiting a positive trend in theirrelative strength and this positive trend is still being pushed higherby a positive momentum. As wel all know momentum, or rate of change,is a leading indicator. So as soon as the pace of the RS-Ratio linestarts to fade its rate of change will start to decline. When the rateof change turns negative, the RS-Ratio line has formed a top andstarted to decline.

At this moment, when the JdK RS-Momentum line drops below the100-level, the item moves into the lower right-hand, the weakening, quadrant.

If the weakness in relative strength persists and the negativemomentum continues to push the RS-Ratio line down below the 100-level(on the RS-Ratio axis) the element moves into the lower left-handquadrant of the plot, the lagging quadrant.

In that lagging quadrant we find the elements of which relativestrength is in a down trend which is still being pushed further down byweak momentum.

The up-turn follows the same anatomy as the down-turn. The firstthing that will happen is that JdK RS-Momentum will start to pick up,signalling that the pace of the down trend is faltering. When the RS-Momentumline crosses above the 100-level a low has been formed in the RS-Ratioline which by that time has started to move up. At that time, when RS-Momentumcrosses above 100, the item moves into the top left-hand quadrant, whichis labeled the improving quadrant. Items in this quadrant arestill showing a negative trend in relative strength but the worstis over and the forming of a low is in process.

Eventually when this improvement continues the RS-Ratio linewill rise above the 100-level as well which brings it back into thetop right, leading, quadrant, completing a full rotation.

In order to put the move of an element through the RRG plot intoperspective the observations can be connected which creates a 'trail'.This trail shows the rotation over the past n observations and asit is based on a trend-following approach a continuation of thatrotation may be assumed under normal circumstances.

A static RRG plot shows the trail over the past n observations,dynamic RRGs show the trail over time moving it forward one observationat a time. This creates the 'snake-like' movement thatvisualizes rotation of relative strength among elements in a universe.

RRGs or Relative Rotation GraphsTM (yes they are officiallyTradeMarked) are a visualization method to picture the relative positionof all elements in a universe of securities against a benchmarkand against each other. This means that RRGs can save the user timeand provide additional insight which can not be achieved usingregular relative strength charts.

A 'universe' can really be a collection of any sortof traded instruments/securities you like as long as their priceseries are comparable! Plotting an equity index in combination witha yield series in one RRG will cause problems on interpretationbecause of the inverted nature of a yield graph. As long as all elementsof the universe are comparable RRGs can be used to analyse theirrelative strength.

As Relative Rotation Graphs are a visualisation method thereare no fixed trading rules. It is best to compare a RRG with a regularchart. A very aggressive trader may want to buy a 5-bar breakout whilea more conservative trader would like to buy a 20-bar breakout.

Interpretation on RRGs is the same. A very aggressive tradermay want to look for buying (relative) opportunities when securitiescross into the top-left 'improving' quadrant while moreconservative traders may want to wait until the security reaches the top-right'leading' quadrant.

When you bring up a Relative Rotation Graph with a lot of securities,say the S&P 100, at first the chart may look like spaghetti

As a rule of thumb you can say that the cluttered securities aroundthe middle (=benchmark) of the plot are not worth exploring as theyare moving, more or less, in line with the benchmark. The more interestingsecurities are found on the edges of the plot making the bigger rotations.

Both RRG on Bloomberg and the RRG-toolbox on MA offer the opportunityto toggle the trails on or off so you can quickly identify the securitiesthat you may want to do a further analysis on.

We want to use 140 days as our Long Term Price change and 20 daysfor our Short Term Price Change. Thus we get:

( ( Close-Close[140] + Close-Close[20] ) / 2 ) / 10 Day ATR

a shorterterm, normalized measure

and a longerterm, normalized measure is provided here.

Short Term

Long Term

In each case a second risk-adjusted ranking is completed bydividing the RS measure by its 26-week standard deviation.

The RSI Ratio values are maintained daily and weekly, respectively,and the nine SPDRs ranked on Fridays (Thursday if the markets areclosed on Friday).

Two SPDRs are held with all four systems based on their relativerankings. The system signals are generated and implemented as follows:

Calculate the RSI Ratio and rank SPDRs at the end of the tradingweek.

Buy Signal

Hold Signal

Sell Signal

longterm,

mediumterm

and shortterm.

* Percent above/below 200day EMA (30%)

* 125Day RateofChange (30%)

* Percent above/below 50day EMA (15%)

* 20day RateofChange (15%)

* 3day slope of PPOHistogram (5%)

* 14day RSI (5%)

The market is in offensive mode when the technology, and consumerdiscretionary sectors lead.

The market is in defensive mode when consumer staples, healthcareand utility sectors lead.

Once the leading sectors have been determined, chartists canthen look within these sectors to find the leading stocks.

Sectors that show relative weakness can be avoided to help narrowthe search.

As with all indicators, it is important to use the Price Relativein conjunction with other technical analysis tools.

momentum oscillators and chart patterns can be used to confirmor refute relative strength or relative weakness.

- the ratio between the closing price of the two data sets on thespecified intercept date.