How to calculate the Stock Market Relative Strength
The Stock Market Relative Strength compares the prices of two financial instruments: stocks or indexes.
It’s possible to create an indicator that compares the historical series of Apple with the historical series of the Nasdaq index. Nasdaq Index is used as a benchmark.
We can also compare sectoral indices or sector ETFs with the reference stock index.
Stock Market Relative Strength using the Percentage Changes
A first rather simple system is to compare the percentage changes of the last x days of two actions.
In this way, a ranking will be created where we will find the title that has best performed in the first place.
Or, you can calculate the ratio between the percentage changes of X days. In this way, you haven’t a ranking but an absolute comparison between two instruments.
Another method, always using the percentages of daily gain and loss, is to check how many times the stock has outperformed the Benchmark Index in X days.
Relative Strength using the Spread
You can also create an indicator that calculates the ratio of the entire time series of the two instruments. This is the spread chart you can get in Forex with currency pairs.
Let’s take EurUsd as an example; its graph is the relationship between the Historical data of the Euro and the Dollar.
Imagine you create a Netflix / Nasdaq chart when the line goes up; it will mean that Netflix outperforms the Nasdaq and vice versa.
This graph will be possible to insert a series of indicators, such as RSI, Moving Averages, etc.
Also, in this graph, it’s possible to find many patterns.
For example, assume that Netflix tends to outperform the Nasdaq Index for X days and then returns. In this case, we could use mean-reverting strategies to open a trade.
We could use an RSI indicator to predict that when the ratio of Netflix to Nasdaq rises above a specific value, it tends to fall. So when the RSI of our Relative Strength Indicator exceeds a certain value, we can sell Netflix and buy Nasdaq.
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Resources: Wikipedia