THE HAnDbook of TECHnICAl AnAlysIs■ (^) Identifying divergence via peak and trough analysis
■ (^) Comparing the percentage or ratio performance of two or more price ratio
charts from a common reference point or time line
Relative strength measures the performance of one security, index, or com-
modity against another. There are basically two ways to create a relative strength
chart, that is, either by the ratio or difference method:
■ (^) Ratio method: Divide the closing or open, high, low, and close (OHLC) price
of one security by another for each period and plot the ratio on a chart.
■ (^) Difference Method: Subtract the closing or OHLC price of one security from
another for each period and plot the difference on a chart.
Relative strength charts are usually used to compare the performance of:
■ (^) A security against another security, index, or commodity
■ (^) An index against another index or commodity
■ (^) A commodity against another commodity
■ (^) One interest rate against another interest rate
Normally, relative strength charts are employed to gauge the strength of a
security within the market environment by comparing it to a broad market in-
dex. Some markets are actually based on the charting of relative strength, such
as the foreign exchange (fx) markets, where the price of one currency is divided
by the corresponding price of another currency for each period and the ratio is
plotted as a currency pair. Many commodity traders also use relative strength
charts that are based on the spread between the price of one commodity and
another, usually either between different contract months or between different
futures exchanges.
applying technical analysis on relative
Strength Charts
We can apply technical studies on relative strength charts since they are simply de-
rivatives of actual prices. We may employ trendlines, channels, moving averages,
chart patterns, and oscillator analysis. Identifying divergence between a security
and its relative strength with respect to an index or another security is a very
popular way of forecasting potential reversals in the security.
Being derived from regular price charts, relative strength action shares all the
same characteristics as price. Just like price action, it displays:
■ (^) Trends
■ (^) Reversals
■ (^) Consolidation
■ (^) Chart patterns
■ (^) Gapping action
■ (^) Volatility