As of 10/29/2020
  Indus: 26,659 +139.16 +0.5%  
  Trans: 11,184 +237.90 +2.2%  
  Utils: 868 +2.32 +0.3%  
  Nasdaq: 11,186 +180.72 +1.6%  
  S&P 500: 3,310 +39.08 +1.2%  
YTD
-6.6%  
 +2.6%  
-1.3%  
 +24.7%  
 +2.5%  
  Targets    Overview: 09/29/2020  
  Up arrow29,300 or 27,400 by 11/01/2020
  Up arrow12,000 or 11,000 by 11/01/2020
  Up arrow915 or 840 by 11/01/2020
  Up arrow12,800 or 11,300 by 11/01/2020
  Up arrow3,700 or 3,400 by 11/01/2020
CPI (updated daily): Arrows on 10/23/20
As of 10/29/2020
  Indus: 26,659 +139.16 +0.5%  
  Trans: 11,184 +237.90 +2.2%  
  Utils: 868 +2.32 +0.3%  
  Nasdaq: 11,186 +180.72 +1.6%  
  S&P 500: 3,310 +39.08 +1.2%  
YTD
-6.6%  
 +2.6%  
-1.3%  
 +24.7%  
 +2.5%  
  Targets    Overview: 09/29/2020  
  Up arrow29,300 or 27,400 by 11/01/2020
  Up arrow12,000 or 11,000 by 11/01/2020
  Up arrow915 or 840 by 11/01/2020
  Up arrow12,800 or 11,300 by 11/01/2020
  Up arrow3,700 or 3,400 by 11/01/2020
CPI (updated daily): Arrows on 10/23/20

Bulkowski on Relative Strength

 

This article discusses a different kind of relative strength, that of comparing the performance of a stock versus the Standard and Poor's 500 index. Knowing the right combination (rising or falling) when trading chart patterns can boost profits while lowering risk of failure.

Relative Strength: Summary

Relative Strength: Background and Methodology

There are several types of relative strength. First, there's Wilder's relative strength index (RSI), which is a popular indicator. Then, there are studies I conducted on relative strength of industries, where I compare the price performance of several industries to one another, and stocks, whereby a trader or investor selects the strongest performing stocks to buy.

This study compares the performance of a stock with the Standard & Poor's 500 index.

Picture of relative strength.

The above chart shows an example of how I conducted the study. A symmetrical triangle appears outlined in red, bounded on the top and bottom by two converging trendlines.

The relative strength line compares the daily closing price with that of the S&P 500's closing price, and it appears on the chart as a jagged blue line cleverly labeled "Relative Strength Line."

Since this line is irregular, I applied a 22-trading day (about a calendar month) simple moving average to smooth it. That line appears in red as a smoothed version of the more jagged relative strength line.

For the study, I looked at the slope of this line at three locations: the day before the start of the chart pattern, the day before the breakout, and a month after the breakout. In this chart, the relative strength line is falling going into the chart pattern and rises when price breaks out of the chart pattern. It keeps rising a month later. As the chart shows, price rises from about 23 to 33 (43%) in about 4 months.

I used 1,094 stocks with data stretching back as far as July 1991 and found 15,763 chart patterns. Not all stocks covered the entire period.

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Relative Strength Results: Upward Breakouts

For stocks with upward breakouts, the following table shows the results based on the slope of the relative strength line.

Before Chart
Pattern
Before
Breakout
Percentage
Gain
Failures
RisingRising32%19%
RisingFalling29%22%
FallingFalling33%17%
FallingRising34%16%

The table shows that when a 22-trading day relative strength moving average line is rising the day before the chart pattern starts and continues rising the day before the breakout, price climbs an average of 32% after the breakout. The rise is measured from the close the day before the breakout to the ultimate high, which is the highest high before price drops by at least 20% (a trend change). Failures are 19%, meaning 19% of those chart patterns failed to rise at least 10% after the breakout. The 10% benchmark is an arbitrary setting, but it is high enough for a trader to cover costs and make a small profit, assuming a timely sale.

The results show that the combination of falling relative strength leading into the chart pattern followed by rising relative strength on exit from the chart pattern gives the best average percentage rise after the breakout (34%). Failures, at 16%, are also the lowest in the table.

The worst performing combination is a rising relative strength line going into the chart pattern followed by it falling on the way out. That combination gives an average rise of 29% with the highest failure rate: 22%.

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Relative Strength Results: Downward Breakouts

The following table shows the results for downward breakouts from chart patterns. The percentage loss column measures from the close the day before the breakout to the ultimate low, which is the lowest low before price stages a 20% gain (a trend change). Failures occur when price drops less than 10%.

Before Chart
Pattern
Before
Breakout
Percentage
Loss
Failures
RisingRising19%28%
RisingFalling21%28%
FallingFalling18%29%
FallingRising21%28%

If the stock is falling faster than the market (falling "before chart pattern" and falling "before breakout"), I would expect a larger decline, and yet the table shows an 18% drop occurs with a slightly higher failure rate (29%) under those conditions. In other words, the results don't make intuitive sense.

For the best performance after a downward breakout, look for a reversal in relative strength, either from rising to falling (21% loss) or falling to rising (21% loss) as measured on the day before the chart pattern begins and the day before the breakout, respectively.

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Relative Strength Results: Post Breakout Relative Strength

As a final test, I looked at the post breakout relative strength results. This compares the gain (upward breakouts) or loss (downward breakouts) when relative strength is rising and falling. The results are what I expected, but the percentage difference between the numbers surprised me.

Relative
Strength
Breakout
Direction
Gain
or Loss
RisingUp41%
FallingUp22%
RisingDown13%
FallingDown25%

The table shows that if relative strength is rising in a stock compared against the S&P 500 index after an upward breakout, the stock soars an average of 41%. This compares to a rise of just 22% if relative strength is dropping.

For downward breakouts, when relative strength is rising, meaning the stock is maintain its current price better than the general market, the stock drops just 13% compared to an average loss of 25% if the stock is weaker than the market.

Finally, don't expect relative strength to continue in the same direction after the breakout as it was before. If relative strength is rising leading to a chart pattern, there is a 49% chance that it will continue rising after the breakout. That's random.

-- Thomas Bulkowski

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See Also

 

Support this site! Clicking any of the books (below) takes you to Amazon.com. If you buy ANYTHING while there, they pay for the referral.

My novels:  Bumper's Story Head's Law

Chart Patterns: After the Buy Getting Started in Chart Patterns, Second Edition Trading Basics Fundamental Analysis and Position Trading Swing and Day Trading Visual Guide to Chart Patterns Encyclopedia of Candlestick Charts Encyclopedia of Chart Patterns 2nd Edition Trading Classic Chart Patterns

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