Once a strong sector has been identified, one can then examine industry groups within that sector to find the strongest. This allows you to zero in on the best stocks in the strongest industry groups of the market-leading sectors.
For investors, it is often the weekly RS analysis that will be the most important, though over the past few years I have been combining weekly and daily analysis. In this article, I will explain how I combine the analysis of these two time periods, and also show why traders should also consider using the hourly RS analysis in their trading.
Unlike most analysts who use this approach, I use moving averages and trend line analysis of the relative performance to help me identify turning points.
This weekly chart of the Select Sector SPDR Energy (XLE) covers the period from late 2009 through August 2012. From October 2009, the RS line had been in a downtrend, as it formed a series of lower highs (line a) and lower lows. It moved above and below its 21-period WMA during this time.
The breaking of long-term up- or downtrends in relative performance is generally quite significant, as the length of the trend line is important. Therefore the break in the yearlong downtrend in October 2011 (line 1) did suggest a change in trend.
By the end of the month, it had formed a bullish zig-zag formation consistent with a new uptrend. The RS line confirmed every new high until the end of April, when XLE closed at $80.47 but the RS made a lower high. The next week, XLE reversed sharply to the downside, and the RS line broke its support (line c).
The RS line did move above its WMA in July, but then reversed, dropping sharply below its WMA and the prior lows. This reaffirmed the downtrend.
From late December 2011 to the middle of February, XLE rallied sharply, hitting a high of $76.50. During this rally, the weekly RS line diverged from prices, as it formed lower lows (line f) and was only able to move slightly above its flat WMA.
The RS line violated its WMA in March, and continued to drop sharply in April, making a spike low in June. The RS line has now moved above its WMA, but is still well below the long-term resistance at line e.
The daily RS analysis shows that it also diverged from prices in April 2011, and completed a top in May, when it broke support (line c). The RS line also rebounded back to this resistance in July.
The daily RS line was negative from August to October, and did not form any divergences at the October lows like other sectors did. The relative performance did move quickly back above its WMA soon after the October lows, but peaked at the end of the month.
The daily RS was also not confirming the price action from November through February, as it also formed lower highs and lower lows, indicating that XLE was weaker than the S&P 500.