Education & Information
Relative Strength Charts
Sector Relative Strength Charts
Along with sector bullish percent charts, relative strength charts for a sector are an important tool to use to help focus on sectors that hold low risk and good opportunity to profit. They will help you focus your investment efforts on the strongest sectors at any given time. Possibly even more important, they also can help your risk management efforts through avoiding exposure to weak sectors that hold high risk.
Sector RS (relative strength) charts record the percent of stocks in a sector that are on a buy signal on their individual RS charts. A buy signal on an individual stock’s RS chart indicates better long-term performance for that stock relative to the overall market.
When fewer stocks within a sector are on a RS buy signal (also meaning more are giving new RS sell signals), that sector will most likely perform worse than the overall market. We want to avoid making new investments in these sectors as our chances of being successful are greatly diminished.
Below is a RS chart for the Software sector. Sector RS charts move a little slower than the sector’s bullish percent chart. Similar to an individual stock’s RS chart, they tend to give longer-term buy and sell signals. Primarily, we are interested in the direction the chart is moving. When more stocks are giving RS buy signals within a specific industry sector, it tells us that sector has a good chance of being a market leader and, therefore, we have a better chance of making successful investments if we focus in that sector. You will see this condition on a sector RS chart when it is rising in a column of Xs. That is when we want to focus our efforts in that sector. A sector RS chart can remain in the same column for a number of months or even a year or longer. The Software sector RS chart was generally advancing from 1995, the beginning of the chart below, until peaking at 62% in March 2000. Those were five great years to own software stocks. Software stocks like Microsoft rose from near $10 to almost $120 and Oracle rose from near $3 to over $40 in that time frame.
The tide turned in April 2000 and this sector’s RS chart reversed down into a column of Os. This change tells us more software stocks are beginning to give sell signals on their RS charts and is a strong indication that software stocks should be sold. The sector’s RS chart continues dropping and as of this writing (September 24, 2002) and currently is back to the same level it was in 1995. Since that sell signal, Microsoft has declined down to the mid $40’s and Oracle is all the way back to single digits.
Using sector RS charts will help you be positioned in a sector during a prolonged advance and help you avoid exposure to a sector during sustained declines.
