Tales of a Technician: Strength, Weakness, It’s all Relative | Tackle Trading
In response to last week’s enlightening post on The Magical Properties of the Dow/Gold Ratio, I received a great question from one of you trading tycoons. Okay, I’ll give him a shout out — thanks to Nicholas Kingsbury for the insightful question.
Side note: you, too, can receive one of these coveted shout outs someday. I mean, who wouldn’t want one? Here’s the trick: be engaged, make comments, and the like. If your query or blathering gets the pistons firing in my idea factory, for a blog post you win a shout out. Deal?
Here’s the question: Is there a good place one can get ratio graphs like that?
Why, yes; yes indeed. I used stockcharts.com to create the ratio chart. Here’s the link. All you have to do is put a colon between two tickers and BOOM!, a ratio chart appears.
Suppose Stockcharts.com slighted you somehow in the past and you’ve sworn you’ll never go there again. (Your loss, but whatevs). There’s actually an indicator in most charting platforms that displays a ratio chart. I’ll use ThinkorSwim charts since most of you probably use that platform. Let me provide a little background first, and a vocabulary lesson for the rookies. Two words: absolute and relative.
On an absolute basis, I’m strong, but relative to Tim Justice (whose likeness I used in my image above) I’m weak sauce.
On an absolute basis, I’m handsome, but relative to Channing Tatum, I’m a troll. (He’s good looking, or so I’m told).
Now, closer to home. The absolute performance of Facebook was solid this year. FB stock ascended 35%. Relative to Netflix, however, FB sucked. NFLX galloped 164% higher. It’s like that dinner scene in the movie Hook where Rufio and Peter Pan are volleying insults back and forth, except its Facebook and Netflix. By himself Facebook (Rufio) is a stud, but compared to Netflix (Peter Pan) he just can’t hack it.
When using the term absolute, we’re talking about something in a vacuum. When using the term relative, we’re making a comparison. While some stock may look good on an absolute basis, they could appear horrible relative to something else. Got it?
This is the whole idea behind phrases like relative strength and relative weakness. Such comparisons are what constitute the relative strength study you can display below your chart in ThinkorSwim. It’s plotted as a simple line which rises when your stock is outperforming whatever benchmark you’re comparing it to and falls whenever your stock is underperforming.
That, my friends, is the same exact thing illustrated in a ratio chart. The Dow/Gold ratio rises when the Dow is outperforming gold and falls when it’s underperforming. Were I to chart the Dow and add a relative strength indicator with gold as the benchmark it would look identical to the stockcharts.com ratio chart I showed last week.
Relative strength is a useful metric for a number of reasons, chief among them being trade discovery. Knowing which asset, sector, or stock is leading the market can narrow down your search and help you in focusing on buying the best of the best, or shorting the worst of the worst. Want to know which tech stocks are besting the Nasdaq Composite? Look at their relative strength indicator with QQQ as the benchmark.
You want to know if bonds are doing better than stocks? Look at SPY with a relative strength indicator using TLT as the benchmark (or vice versa). Or, how about oil versus energy stocks? Use USO and compare it to XLE. The variations are endless.
Ok. I’m off to the gym. Timmy’s picture above has motivated me.
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Originally published at https://tackletrading.com on December 9, 2015.
