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Then & Now: Sector Relative Strength

By Clare White, CMT, Optionetics.com | Tue November 20, 2012 7:21PM PT

 

There are a variety of Relative Strength [RS] approaches to investing and trading. H.M. Gartley’s 1945 paper in the Financial Analysts Journal, Relative Velocity Statistics, is cited as one of the earlier works on the topic.1 Gartley looks at price movement of a portfolio compared to movement in a broad benchmark index in this paper, which is similar to the concept of beta.

 

The Work That Launched 1,000 Approaches

Robert Levy’s Relative Strength as a Criterion for Investment Selection, in the December 1967 Journal of Finance, dug more deeply into a formal RS approach that focused on staying with leaders. He provided results from rigorous testing which used weekly closing data for 200 stocks trading on the New York Stock Exchange [NYSE] from 10/24/60 – 10/15/65 (260 weeks). The three measures calculated included:

  • Current Weekly Close / 26-week Simple Moving Average [SMA]
  • Weekly Close 4-weeks Ago / Current Weekly Close
  • Weekly Close 26-weeks Ago / Current Weekly Close

 

Levy used the first calculation method to complete a weekly ranking of the 200 stocks from 0 through 199 then broke the ranked stocks into ten groups of twenty stocks. Performance was evaluated using the second two measures. Levy’s conclusion was that relative strength does tend to continue over a longer period (26 weeks), but not a shorter period (4 weeks).

Additional work completed by Levy in this paper includes impacts from stock volatility, market timing and excessive market moves (termed “market ranks” and “divergence ranks”).2 The task of exploring these topics further is left to the reader via the original paper which is referenced below.

 

More Recent Work

Charles D. Kirkpatrick, II, CMT and Michael J. Carr, CMT have both authored recent books referencing and expanding the work of Levy. Kirkpatrick’s 25 year performance and Carr’s 10+ year track record have clearly covered a variety of market conditions. The approaches tested and explored by these practitioners include more extensive periods of time and a variety of relative measures including both technical indicators and fundamental ratios. Book references for RS work completed by these traders can be found at the end of this article.

RS work by another technician, Timothy Hayes, CMT of Ned Davis Research [NDR], has also been referenced in the column numerous times. The NDR approach uses a weighted average technique for three Rate of Change [ROC] measurements to rank groups of markets, sectors, and industries. Again, Hayes and NDR completed independent testing for RS techniques and provided results that supported the viability of RS approaches.

 

Jay Kaeppel’s Work

I’d be remiss to not include RS work by our own Jay Kaeppel. Attendees at the second OASIS in San Diego filled the rooms when Jay discussed his different Pure Momentum systems which applied RS approaches to sectors, countries and other related asset groups. Kaeppel’s system ranks price changes over a 240-day trading period and enters a long position for the top ranked sectors. When initially reviewed for the 1999 article, the system outperformed the S&P 500 six of its first nine years. The worst result in the three underperforming years was a return of +17.9%, which would be considered pretty manageable for many.

The system had similar relative performance versus the S&P 500 from 1999 – 2004, with two years in six underperforming the broad average. The worst relative performance year saw a return of +1.1% versus +2.7% for the S&P 500. On a net basis, the Pure Momentum performance surpassed S&P 500 returns with cumulative net gains of +361.1% versus +144.9% for a difference of +216.2% over 15 years.

 

 

1Carr, M., CMT (2008). Smarter Investing in Any Economy: The Definitive Guide to Relative Strength Investing. Cedar Falls, IA: W&A Publishing (p 27).

2 Levy, Robert A. (1967). Relative Strength as a Criterion for Investment Selection, Journal of Finance, Volume 22, Issue 4 (Dec 1967), 595-610 (p 599).

 

References

Carr, M., CMT (2008). Smarter Investing in Any Economy: The Definitive Guide to Relative Strength Investing. Cedar Falls, IA: W&A Publishing.

Gartley, H.M. Relative Velocity Statistics: Their Application in Portfolio Analysis. Financial Analysts Journal, April 1945:60-64.

Hayes, T. CMT (2006). The Research Driven Investor. New York, NY: The McGraw-Hill Companies.

Kaeppel, J. Trade Sector Funds with Pure Momentum, Technical Analysis of Stocks and Commodities 19, no. 11 (July1999), 22-36.

Kirkpatrick, C. II, CMT (2009). Invest By Knowing What Stocks to Buy and What Stocks to Sell. Upper Saddle River, NJ: Pearson Education, Inc.

Levy, Robert A. Relative Strength as a Criterion for Investment Selection, Journal of Finance, Volume 22, Issue 4 (Dec 1967), 595-610.

 

Clare White, CMT
Contributing Writer and Options Strategist
Optionetics.com ~ Your Options Education Site

Questions for Clare? Please visit the discussion board on the homepage of Optionetics.com.

 

 


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