Using Relative Strength in Stock Selection

(By Ken Little)

Do you know the relative strength of your stocks? Do you check the relative strength of the stocks you are considering for investments?

This important metric is one tool you can use in your evaluation of a stock that gives you an idea of how the stock is performing relative to the rest of the market.

Before we look at why you should care about a stock’s relative strength, let’s nail down the definition.

Relative strength is a numerical measurement expressed as a percentage. For example, if a stock has a relative strength of 75 it has outperformed 75% of the stocks over a specified period.

It’s about Price

Specifically, relative strength is about a stock’s price. The percentage change is calculated and compared to the market or some other standard such as the S&P 500 Index.

So, the higher the number the higher the performance. If you look at a stock for a short period, relative strength may not mean much. However, if a stock holds a strong relative strength number for a longer period, say six months or more, then you might be comfortable that the company is legitimately moving forward.

A number of stock screeners let you use relative strength to pick stocks. One I have used is MSN.

Use a Screen

Why should you care about how the stock is performing relative to the market? For some buys, it won’t may any sense. A value stock that you are hoping to pick up for a song won’t show up on a screen for strong relative strength. Of course, you can screen for low relative strength also.

However, if you are looking for a stock that is making a move upward consider using relative strength to measure whether the move is a recent blip or a sustained rise in value.

Stocks that have shown good relative strength over a reasonable period have some market validation. If other investors didn’t like the stock, its price wouldn’t continue to rise.

There’s nothing wrong with buying on the way up and relative strength is one way to identify stocks moving that direction.