May 4, 2007

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In May 2007, Katie Stockton, CMT offered CMT Association Symposium attendees a short tutorial on applying relative strength.

The CMT Association Video Archive contains a number of valuable presentations like this one. While they may seem dated, and some may in fact be out of date, this one is a timeless example of how to analyze the markets. In addition, Katie provides a lot of detail on how she does her job, and seeing how a successful technician works is valuable for newcomers to the business as well as experienced technicians who benefit from seeing what others are looking at.

Beginning with a definition of relative strength, Katie walked through how she uses relative strength and other indicators and wrapped up by giving her current views of the markets. In the first few slides, she demonstrated the diversity of relative strength analysis, which can be used in a number of ways, to evaluate breakouts & reversals and to identify shifts in market leadership.

Relative strength offers a number of advantages, in particular:

  • It’s a time-tested & widely used concept. Technicians have used relative strength for decades, and it can be used for analyzing anything that has a price. Within her presentation, she demonstrated techniques to apply the analysis to global markets and interest rates.
  • The simplicity of the calculation makes it easy to understand, an advantage for technicians selling their analysis to skeptics.
  • The calculation is readily available on almost any software platform.
  • Reveals inter-market relationships that can help develop long-term trading strategies.
  • Relative strength offers a visual gauge of performance, making it possible to analyze a large number of charts in a short time.
  • It’s useful in pairs trading, and in fact forms the basis of this trading strategy.
  • There is a broad appeal to relative strength, and Katie noted that it’s not just for technicians. It can be applied in economic analysis just as easily and is a concept that fundamental analysts can accept.

An interesting application which she demonstrated was using relative strength to confirm breakouts from support and resistance levels. Katie notes that relative strength and support and resistance are among the tools that she finds most useful in her analysis. That is actually a valuable insight that many may have overlooked. Relative strength can precede a price move, and a breakout through resistance or a bounce off of support is logically more likely to follow through with higher prices if the relative strength is in an uptrend. Likewise, a relative strength divergence as prices move through resistance is probably indicating that this would not be a great trade on the long side. The final conclusion from her insight is that a downward trend in relative strength with prices at support levels is likely to be bearish.

Welles Wilder demonstrated that charts patterns and trend lines work very well with indicator analysis. Katie offers several examples that you can see in the video of traditional Edwards and Magee chart patterns forming on relative strength charts. This can be a confirmation of price action or may actually be a leading indicator in some examples. In either case, it is valuable information for the technician to have.

Katie demonstrated the use of other indicators along with relative strength. In particular, stochastics and MACD, along with Rick Bensingor’s TMAP, an indicator combining three moving averages, help her to refine her analysis. There is a danger in relying on only a single indicator, but many beginning technicians suffer from trying to look at too many. Each slide that she presents shows a clear analysis, and the video demonstrates simple ways to look at the charts to form clear conclusions.

Another unique part of her presentation included a list and discussion of the drawbacks of relative strength analysis. Many speakers rely on the well-selected example to make their point, and avoid discussion of what can go wrong. Every experienced trader knows that the market involves a great deal of uncertainty and successful traders take time to consider what can go wrong. Her list included:

  • Secondary indicator based on price
  • Risks of long-term analysis
  • Tech bubble (there were no negative divergences to warn of the crash)
  • Choosing comps can be difficult
  • Confused with Relative Strength Index (RSI)

In the video, each of these points is explained in detail. The fact that she acknowledged and skillfully discusses potential pitfalls proves that she works in the real world and this is not a theoretical discussion but instead is offering the audience the benefit of experience. It is often said that experience is the best teacher, but it is also usually the most expensive. This slide can help save thoughtful analysts a great deal of time by highlighting what they need to pay attention to in the real-time pursuit of profits.

It’s interesting to see an analysis of the markets at such a critical time. Katie noted a large number of relative strength divergences and called for investors to be selective in banks and real estate, among other sectors. The fact that she made a number of very good calls is less important than the opportunity to see the thought process that was applied at that time. Technicians trade on the right side of the chart (the present time) and her analysis was done along that right edge. With the benefit of hindsight, we know what she got right and wrong, but this video offers a valuable approach to analysis. Even if you don’t use relative strength, you can see an analytical process that can be applied to any indicator.