Maybe you’re on Twitter or you’re watching CNBC, and you hear someone harping on about relative strength. But you don’t know what it is, so you just chalk it up to some financial jargon to look up later and move on with your day.
Well, relative strength is a very simple and powerful concept.
In essence, it’s a stock that is showing strength relative to the market. Say the S&P 500 is down 1% on the day, yet Apple (AAPL) is up 1%. That’s a stock showing relative strength. On a one-day measure, relative strength isn’t all that convincing. But say the market is going through a really choppy period or is under a lot of selling pressure for a prolonged stretch. When a stock is standing tall during that period of time, then it’s really worth a closer look.
I like to post about relative strength plays on Twitter. Some will ask me why it matters; what good does this knowledge do?
Not only are relative strength plays a good place to “hang out” during market turbulence, but they usually outperform when the market comes back to life as well. When I say “hang out” I don’t necessarily mean buy and hold. Sometimes that strategy plays out well. But other times, the relative strength plays get taken out to the woodshed too.
However, they are generally good stocks to invest in or trade with while the market is going through its crazy spell. Further, they tend to be traders go-to names when the market finally comes back to life.
Examples of Relative Strength
Roku has been a total stud so far in 2019. It’s one of the market’s strongest participants. Ignoring the fact that shares more than doubled from January through March, look how well it did in May and August. In both months, the S&P 500 (shown below) struggled, while volatility increased significantly.
It’s almost as if Roku gets more juice as volatility and selling creep into the indices. We’ve seen it twice now and while I think Roku is overbought, it’s been very impressive.
Starbucks held up pretty well in May, losing less than 2%, and gained steam in August while the indices struggled. It wasn’t quite Roku-strong in those months, but impressive given its 81% one-year gains vs. a flat S&P 500.
But here’s where SBUX really shined — against Roku and the S&P 500.
Look at it during the fourth quarter. In Q4 we saw the S&P 500 lose 15%, while the Nasdaq shed almost 20%. Volatility was rampant and things were getting ugly. That is, unless you owned SBUX. Shares rose in October, logged big gains in November and while they stumbled in December, still ended the quarter +14%.
That’s damn impressive in the face of a market-wide meltdown.
Final Thoughts on Trading RS
When the market is going through its turbulent period, it’s best to already be long these relative strength plays. Unfortunately, timing the market is no easy gig and knowing which high-flyers will stand tall only complicates things.
But the more quickly you can identify relative strength plays, the better. They are usually the ones that hold up the best amid the storm and they also tend to outperform when the tides turn back in the market’s favor.
Admittedly, it’s a bit perplexing when they don’t lead the way on a market rebound, but nevertheless, quick identification often pays off for stock observers.
Consider that if you had noticed how well Roku had done in May, perhaps you would have been long it coming into summer and through the August volatility. Same perhaps with Starbucks coming into 2019 or any one of the other dozen-plus names throughout the year.
Hope this helps, happy trading!