Is momentum relative
Relative Strength and Momentum: Importance and Application
If you read stock market reports and assessments of stocks, you will come across the term "relative strength" over and over again. But what does that mean?
Put simply, a stock that shows relative strength outperforms the market as a whole. But there is much more to it than that:
Different relative strength concepts
Strictly speaking, the term “relative strength” can mean different approaches. You will often find the Relative Strength Index (RSI) developed by Welles Wilder displayed in charts.
This is a technical indicator that ranges from 0 to 100%. The RSI shows whether a stock is oversold or oversold, but it is not very suitable for generating buy and sell signals.
Another concept of relative strength works like this: You divide the price of a stock by its index level. If you do this regularly, you can see over time how the stock in question is performing in relation to the index.
If the calculated relative strength value increases over time, the stock will perform better than the index. If the value is trending down, the stock is rather weak.
This approach is interesting, but difficult to implement for investors who do not have professional chart software.
Proven concept: The Relative Strength according to Levy
The third - in my opinion the most interesting - concept is Levy Relative Strength (RSL). The American Robert Levy presented his approach back in 1967. It is based on the assumption that an above-average development will continue in the future; so that an existing trend continues.
Because his approach brought significantly better results than the overall market, Levy caused a sensation in the financial sector at the time. In fact, the approach still works today.
Against the background that sustainable trends often last a long time, the Relative Strength according to Levy is a good opportunity for you as an investor to find stocks that are particularly trending.
This is how the Relative Strength according to Levy is calculated
You can calculate the Relative Strength according to Levy by dividing the current share price by the average closing price of the previous weeks. Levy used the average for the past 27 weeks. The observation period can, however, vary depending on the investment horizon.
For example, if you are more long-term oriented, you can divide the current price by the average of the closing prices of the past 12 months.
If you do this calculation, the result will be the relative strength of a stock hovering roughly around 1. If the value is above 1, a stock is relatively strong. If the RSL is below 1, it tends to be weak.
In the next step, a ranking list is created from the relative strength figures of all index values - for example the 30 DAX stocks.
The available capital is then invested equally in the six stocks with the highest relative strength. After six months, the selection is checked and the values that are no longer among the top six in the ranking are exchanged.
Good tool for stock selection
For you as an investor, the Levy concept can be of great help. However, investors who follow Levy's strategy are always fully invested. Thus, even with this strategy, significant setbacks cannot be avoided in pronounced downtrends.
On the other hand, if you focus on stocks with an RSL above 1 when choosing stocks, you automatically bet on strong stocks with an intact upward trend that offer you above-average profit opportunities. This ensures that investors are always automatically invested in the strongest stocks in an index.
Levy Relative Strength is included in many of the charting tools you can find on the Internet. So you can start looking for promising stocks yourself.
Momentum vs. Relative Strength - Different statements
Both the term ‘momentum’ and relative strength ’will probably sound familiar to all investors.
Both designate important price indicators and are also linked to a special investment or chart strategy.
Due to the similarity of the statements that can be made, the terms often get mixed up.
We explain again, step by step, the difference between momentum and relative strength.
The momentum as an expression of a surge of strength
Let's start with a very brief summary of the meaningfulness of the respective economic term.
What exactly is called momentum again? Momentum is an important metric in technical analysis.
It provides information on the speed and strength of price movements and trend reversals.
Prices that receive a boost usually continue to rise; the more shares receive such a boost, the further they are carried up in price.
To determine the momentum of a share, the difference between the current price and a price in the past, for example 30 days ago, is calculated and updated every day.
The result is an oscillator graphic with deflections that oscillate around the zero line.
The momentum curve can be analyzed like a chart.
Turning points in the lower area of the curve can be interpreted as buy points, while turning points in the upper area can be interpreted as sell signals.
For this evaluation, chart technicians usually choose a setting of 20 days.
Momentum strategy: this is how it works, part 1
Momentum strategy: this is how it works, part 2
Difference Between Momentum and Relative Strength
In general, it can be said that both indicators are important instruments for chart analysis and thus for your investment decisions.
The momentum indicates an index value that is based on a comparison of the closing prices of a certain share over a certain period of time.
The relative strength, on the other hand, indicates a ratio between a share price and the general technical average value.
Both instruments can therefore be used to analyze trends.
The momentum analysis is often considered to be finer and therefore more precise than the trend analysis based on relative strength.
But which system is preferred is basically up to each investor, because both have their specific advantages and disadvantages.
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