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Do Or Die

Relative Strength- Resources and Glossary

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The stuff here is written from a stock trader’s perspective; however, you can go through appropriate concepts on price behavior to fit for other markets.

 

The Internal Relative Strength (IRS) of a Stock is a generic concept measured by most oscillators. This thread discusses many oscillators from scratch. Constance Browne discusses RSI in detail in her book Technical Analysis for Trading Professionals (Ch. 1,3 and 8 only, poorly written). William Dunnigan did a chart pattern based research (Repeat Signals) which is effectively same as oscillator divergences. Divergences in detail are also covered here; while you can see here a real time example to anticipate a divergence before market actually marked bottom. The other important application of IRS is in identification of Trading Regimes. A relevant book is Trading Regime Analysis: The Probability of Volatility.

 

Comparative Relative Strength (RS) refers to comparing one instrument's performance with another to establish a lead/lag relationship. See this thread for practical application. The most effective application of RS is Sector Rotation. A large number of books in past decade discuss the sector rotation model, however, the first major books were S&P's Sector Investing: How to Buy The Right Stock in The Right Industry at The Right Time and The All Season Investor by Martin Pring. The other important use of RS studies is in Intermarket Analysis and Active Asset Allocation. Technical Analysis: The Complete Resource for Financial Market Technicians by Pring Martin is reference book which gives a comprehensive view in RS.

 

GLOSSARY

 

Relative Strength literally means how a stock is performing comparative to past period or a related market. It is commonly used for comparative relative strength.

Comparative Relative Strength (RS) means looking for appropriate relationships between a stock and its competitor; or between the stock and a related market like its peer group or stock market index.

Internal Relative Strength (IRS) means comparing performance of a security with relation to performance in a past period.

Divergence is a condition where the internal RS of a stock increases (decreases), though its prices may appear to be at same level. In more generic terms, divergence means that the price of one instrument may be moving in different direction relative to an index or oscillator.

Rotational Trading means maintaining a long (short) position in stocks which are relatively strongest (weakest) in the related market.

Oscillator is a technical analysis indicator which is moves within a defined range.

Trading Regime refers to market phases which tend to favor one set of strategies to another; i.e. in a particular trading regime certain set of strategies will be more profitable.

The seven major Stock Sectors are Consumer Staples, Health Care, Utilities, Financials, Technology, Consumer Discretionary and Industrials; the last 4 usually lead the market while the first 3 lag with the market. Energy tends o be independent from the stock business cycle.

Business Cycle means one complete bull and bear market wave. The Stock Market tends to be a leading indicator for the entire business cycle which is a macro economic event.

 

Please use the hyperlinked threads for discussion, this thread will serve for collection of resources only.

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Empirical Research

 

The academic community has dumped most of technical analysis techniques as voodoo; however, RS has been validated repeatedly.

 

One-month Individual Stock Return Reversals and Industry Return Momentum

Marc W. Simpson, Emiliano Giudici, John T. Emery

August, 2011

 

That is, a strategy that buys the losers within the previous month’s winning industry and shorts the winners in the previous month’s losing industry significantly outperforms an overreaction-based strategy that simply buys losers and shorts winners in the market overall, and it outperforms a industry-momentum-based strategy that simply buys the previous month’s winning industry portfolio and shorts the previous month’s losing industry portfolio.

 

Optimal Momentum: A Global Cross Asset Approach

Gary Antonacci, July, 2011

 

Fixed income securities become active in the portfolio only when they exhibit stronger momentum than equities... Practitioners sometimes call it relative strength investing.The results are extraordinary risk adjusted returns at a reasonable level of volatility.

 

Industries and Stock Return Reversals

Allaudeen Hameed, Joshua Huang, G. Mujtaba Mian

March, 2010

 

A return-based trading strategy that capitalizes on the inter-industry momentum and intra-industry reversals produces a monthly, risk-adjusted return of 2 percent.

 

What Does Equity Sector Orderflow Tell Us about the Economy?

Alessandro Beber, Michael W. Brandt and Kenneth A. Kavajecz

June 2008

 

The empirical foot-print of sector rotation has predictive power for the evolution of the economy, future stock market returns, and future bond market returns, even after controlling for relative sector returns.

The Halloween Effect in US Sectors

Ben Jacobsen, Nuttawat Visaltanachoti

May, 2006

 

Halloween effect…is almost absent in sectors related to consumer consumption but is strong in production sectors. There are, large differences across sectors and industries.

 

Cross-Industry Momentum

Lior Menzly, Oguzhan Ozbas

February 2006

 

Trading strategies that consist of simultaneously buying and selling industries with respectively high and low returns in upstream or downstream industries over the previous month yield significant profits.

Momentum

Narasimhan Jegadeesh, Sheridan Titman

October, 2001

There is substantial evidence that indicates that stocks that perform the best (worst) over a three to 12 month period tend to continue to perform well (poorly) over the subsequent three to 12 months.

 

Predicting Stock Returns Using Industry-Relative Firm Characteristics

Clifford S. Asness , R. Burt Porter , Ross L. Stevens

February, 2000

 

We find that within-industry momentum (i.e., the firm's past return less the industry average return) has predictive power for the firm's stock return beyond that captured by across-industry momentum.

Do Industries Explain Momentum?

Tobias J. Moskowitz , Mark Grinblatt

March 1999

 

Iindustry momentum investment strategies, which buy stocks from past winning industries and sell stocks from past losing industries, appear highly profitable, even after controlling for size, book-to-market equity, individual stock momentum, the cross-sectional dispersion in mean returns, and potential microstructure influences.

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