Using Moving Averages of Relative Strength for Signals

12/22/2009 12:01 am EST

Focus: STRATEGIES

One of the most valuable indicators that I keep on hand is the NASDAQ versus S&P 500 relative strength (RS). It is designed to show periods of extreme growth by highlighting periods of outperformance (or underperformance) in progressive tech names.

As you know, market leaders like Apple (AAPL), Google (GOOG), and First Solar (FSLR) are listed on the NASDAQ exchange, so we look for the tech-heavy index to signal periods of strong market growth. Generally, the NASDAQ versus S&P 500 RS is used as a market timing tool and it works on multiple time frames. I review this on hourly, daily, and weekly charts on a regular basis.

Below is a chart of the weekly NASDAQ 100 (QQQQ) with the relative strength (RS). Here's a brief description of what we look for:

When the ten-day simple moving average crosses above the 21-day simple moving average of the relative strength (RS) line, this creates the bullish setup for this indicator. It is only confirmed when the Nasdaq composite closes in a future day above the Nasdaq composite high on the day of the bullish RS crossover. This will then typically start a new uptrend phase for the markets, as the Nasdaq leads to the upside as money managers will be playing "offense" and moving more money into growth-oriented stocks. If the RS crossover is not confirmed, then that Nasdaq composite high is considered the top for that move, usually a peak in a trading range or an evolving downtrend.

Bottom Line: Recent underperformance of the NASDAQ is supportive of a weekly outlook of broad market weakness.  Notice that the March bottom was pinned by a buy signal in the RS. Since the March bottom, this is the first signal (long exit). An actual short signal would only be confirmed if we closed below weekly S&P lows (1,033.57).

chart
Click to Enlarge

By Moby Waller of BigTrends.com

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