Relative Strength at Its Simplest

12/08/2011 10:15 am EST

Focus: TOOLS

Joseph Fahmy

Managing Director, Zor Capital, LLC

Investment strategist Joe Fahmy uses a simpler form of relative strength that doesn’t require indicators and works well in all time frames.

All traders are looking for ways to find good opportunities in the market, and one way is with relative strength.

Our guest today is Joe Fahmy, and he’s here to talk about how he uses it to find the big winners. So, Joe, talk about how you use relative strength.

My definition of relative strength, it’s not RSI, it’s not an indicator; I just use a simple definition: relative to the market, stocks showing strength.

It’s about as simple as it gets, and what I mean by that is when we have corrections, strong stocks stick out like a sore thumb. So going back to corrections from 1997 and 1998, 2000, all the way up to recent corrections, 2009 and 2011, when the market corrects, there are always stocks that are holding up. 

I like to think of it as a spring, so the market is holding these stocks down and as soon as the tension is relieved off the market, these stocks can go on to become big winners. That’s how I use relative strength.

Is it an actual line on a chart or a number you’re watching, or are you just monitoring the stock going up as the market is coming down?

I’m paying attention during corrections. It’s a very good question, because people say “OK, how do you find this?” and I hate to sound so simple saying this, but I just pay attention. 

In other words, if you have three stocks that are $50 and the market goes into a correction, one could be down at $40, one could be down at $30, and one of them is just sitting there at $50, and so a light bulb should go off and you should say “Wow, the market just got killed here and this stock is not even budging.” 

It’s not the smaller guys who are controlling the markets; it’s the bigger guys who are controlling the markets.  The big hedge funds, mutual funds, and pension funds, they’re buying hundreds of thousands, if not millions of shares, and they have a huge luxury that the individual investor doesn’t have, which is teams of analysts that can go out and do their due diligence and really tell if something is going to be a big winner.

They usually won’t sell those shares during the corrections, and that really shows that when you just notice the market is in a correction—whether it’s a two- or three-day pullback, a two- or three-month pullback, or a longer, nine-month bear market—you can really see stocks that are holding up relative to the market showing strength.

Do you do this intraday as well? Could you even mark it down for the day?

Exactly, that’s a very good point. No matter what your time frame is, if you’re a daytrader, a swing trader, or a long-term investor, you can use this on multiple time frames.

Intraday, for example, some news will come out—and this happened a couple years ago—news came out of a subway bombing in London, and the Dow gaps down 200 points.

When the dust settles, it’s a knee-jerk reaction, and people say “OK, this is an isolated event; it’s not going to affect our economy.” 

Let’s say you have 30 stocks on your watch list, and the market is down and everything is red. What I like to pay attention to are the ones that are turning green first on the day, because if the 200 points intraday didn’t weigh them down, trade the ones that are turning green first on your screen. If you feel the market is coming back, that’s how you can use it in a daytrading environment.

Alright, so you said “just as they turn green.” Do you wait a few minutes to make sure that it’s confirming that, or do you try to get in as soon as possible?

Well, if you’re a daytrader, I’d like to think you have some sort of technical intraday patterns that you look for, whether it’s your short-term, one-minute or five-minute charts, or—I don’t do that much daytrading—but you want to buy it off of some sort of a sound place where you have a safe entry and a logical stop. 

You could just blindly buy them as they turn green and then when they turn back red, that could be your stop or you would then move your stop to breakeven or something, but you want to see the ones even on an intraday basis showing strength relative to a down market.

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