Relative Strength is an investment strategy based on the belief that winning securities will continue to outperform. It provides a way for advisors to identify leading stocks in sectors and other market segments based on their history of outperformance. The premise is that investors should only invest in the areas of the market that have shown the ability to outperform. Investors should stay with those securities as long as they continue to outperform and then sell when they begin to fade.
Since relative strength is based on price, and not on fundamental research or your gut, emotion doesn’t Companies, sectors, and other market segments can establish themselves as leaders and even remain as leaders for years to come.
Relative strength can also identify areas of the market that have weakened and should be avoided. This can help your portfolio adapt to market swings. It can also help you to manage risk. However, you should note that relative strength will not be able to target a stock’s exact top or bottom as no investment strategy can be expected to do so consistently. Plus, waiting for confirmation that a stock is in fact a leader, allows you to avoid stocks that are short-term winners, but fail to establish themselves long-term.
Relative strength’s ability to deliver outperformance has been demonstrated by numerous academic and financial studies. Since relative strength is simply the comparison of price performance in a universe of securities, it’s not difficult to develop a rules-based system for investing in high relative strength securities.
Nasdaq Dorsey Wright helps advisors identify Relative Strength stocks and sectors for them to include in their client portfolios. Click here for a free trial of relative strength research and tools.