Clear Relative Strength Rules That Work

06/15/2012 10:45 am EST


Ron Wagner

Principal Partner,

A few simple actions taken to assess a stock’s relative strength can do wonders in keeping traders on the right side of the markets, explains Ron Wagner from

Last time, I showed you a relationship of stocks all gapping down (see “Sympathy” Gaps: Proven Paths to Profit). This time I want to show an example of everything gapping up and moving up.

The S&P 500 is, of course, a representation of 500 stocks that are, in total, moving up or down at any given time. Although this example is showing how the entire day ended up, I have found that looking at the top or bottom sectors and then trading your preferred stock will provide the greatest range.

On the left-hand chart below, you can see how the S&P 500 closed 1.31% higher for the day. On this day, the Dow Jones Transports were one of the strongest sectors. I studied this sector on multiple time frames and determined early on in the day that the sector had room to move. In other words, it wasn’t overextended.

This simplified my mission. I have favorite stocks in each sector that I prefer trading based on a very specific set of criteria. I like to find stocks that trade in specific ranges, have specific trading volumes, and also meet my price range requirement. By going through these simple steps, I am already predetermining everything except for the exact pattern, entry, and the stock market environment.

I found that in this case, on this day, transport stock Con-Way (CNW) had relative strength as compared to other stocks in the same sector and had a much better range it could move up into.

See related: Spot Leaders and Losers with RS Analysis

Now my job was simplified, and all I had to do was sit back and wait for one of my patterns to develop and make sure the market and sector were in alignment.

You can see where all the circled 1’s are marked that all three were in alignment. You can also see where the circled 2’s are marked (shortly after both the market and sector broke out), which was when CNW moved very aggressively. Sometimes the stock will move just before the market and sector, and other times, just shortly after, as in this case.

You can clearly see how CNW closed over 5% higher on the day. I like to trade in this fashion because it’s much easier to outperform the sectors and market on most trades.

Click to Enlarge

I use the same strategies when considering swing trades or longer-term holds. When we have the rapid sector rotation we are now experiencing, it makes more sense to consider all these points, which is actually very simple to do.

See also: Telltale Signs of Sector Rotation

A lot more criteria are important to apply to our potential trading candidates, but that is beyond the scope of this article. Needless to say, it’s always best to be trading those candidates that have the most relative strength as compared to the market and sector. Remember, the market is a composite, or average, of all stocks, so we can always find relatively weak or strong candidates and trade in the direction of the current market trends.

This same strategy, of course, can be used when trading on the short side.

When I first started trading and investing my own accounts over 15 years ago, I felt I had to know everything about the mechanisms of the market, indicators, patterns, strategies, and so forth. Over the last 13 years, I have learned to use only what makes me money consistently.

I have found that the simplest concepts are the ones that produce the best results. My daily routine is completely organized and structured. I have cut out all the complicated stuff. I now trade for income the first 90 minutes after the market opens and then manage any swing or longer-term trades as appropriate.

See related: How to Master the First 90 Minutes

It’s just a matter of what kind of treasure you’re looking for and then sticking to your plan to find it!

By Ron Wagner, active trader, investor, and principal partner,

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