If you have good risk controls, and the ability to deal with lots of volatility, then relative strength has been a good strategy — regardless of market conditions:
"Over the very long term, covering multiple decades and including several major bull/bear cycles, no stock selection strategy beats Relative Strength (RS). This strategy is easy to understand: Buy and hold only the strongest stocks. When a stock slips enough so that it is no longer among the strongest, sell it and replace with whatever is the new strongest.
The RS strategy has been successful for a very long time. Samuel Eisenstadt, Research Chairman of Value Line Investment Survey, found that the top-ranked stocks by RS beat the Standard & Poor’s 500 Index by 4.5 to 1 over a 15-year test period. RS is an important component of Eisenstadt’s Value Line Ranking System. In another independent study, Charles D. Kirkpatrick II, CMT, found that the top-ranked RS stocks outperformed the indexes by 4.7 to 1 over a 17-year period. Many other studies have arrived at the same conclusion."
Apparently, it works just as well with ETFs:
Colby’s column gives more details, along with his list of preferred ETFs. But he notes that:
"Because excessive speculation is inevitably followed by a return to reality, chasing RS fell out of favor for a few years after the top in March 2000. But the RS strategy is very much alive and well again since August 2004. Since August 2004, true to typical form, the strongest stocks have suffered large declines in minor market corrections, but they have been very quick to spring back to the top when the correction has run its course."
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Source:
Applying the Relative Strength strategy to ETFs
Robert W. Colby, TradingEducation.com
Marketwatch, 4:12 PM ET May 25, 2006
http://www.marketwatch.com/News/Story/Story.aspx?guid=%7B734D0841%
2DADBF%2D49E2%2DA1F4%2D10BD51167B9F%7D&siteid=mktw&dist=
Colby is describing Beta not RS, as a strong stock would not plunge during a minor correction. Do these folks understand what they are writing about? Or am I misreading this and crabby due to lack of enough caffeine this morning?
As an aside, I think (though I do not know this for fact) Jeff Vinik, one of my heros, was a big believer in trading RS and look at his track record post Fidelity…considering the amount of money under management, an amazing achievement.
I subscribe to one of the highest ranked newsletters – NoLoad FundX which also uses a RS strategy. I, however, use it almost exclusively for ETFs in the recommended sectors. With ETFs instead of managed funds I found that there is less turnover and a good chance to get long-term gains. Their relative strength strategy consists of averaging the 1 month, 3 mo., 6 mo., and 12 mo. returns of all funds and ETFs and ranking them – highest value the best.
Here’s the potential problem: Their recommended portfolio is currently 80% international with 15% of that in emerging markets. These sectors have taken the brunt of the decline, so far. I did not follow this allocation.
I wonder about your statement that relative strength has been a good strategy. Looking back, those stocks or sectors with high relative strength have done well. Of course, we can all invest looking in the rear view mirror. But how do we know which stocks or sectors will have relative strength going forward? And how do we know when a stock or sector has stopped outperforming, versus undergoing a periodic “relative strength correction”?
RS is a trendfollowing strategy. While there is evidence that trendfollowing works, there is some indication in the data that it works less than it once did, at least in developed markets. Moreover, as I like to say, trendfollowing works until it doesn’t.
Put it this way: who here is long GM?
With so many hedgies leveraging capital several multiples by borrowing at 0% in Japan and piling into anything that was going up, the RS strategy seems especially vulnerable if Japan is serious about eventually tightening. The stuff that worked the best on the way up will probably get hurt the worst on the way down.
There is evidence trend following works? Understatement of the century. Ever hear of a guy named Richard Dennis? LOL.
So we have to buy his book to understand how he calculates Relative Strength, which is apparently not the same as an RSI?
A 21-month period is far too short to draw any reliable conclusions from.
Look at the volatility on the graph. I think you could get the same result by leveraging your purchase of SP500.
What am I missing here, this seems to be Wall Street’s
b.s., buy high sell low. Buying when the RS is high then selling when it moves down?
This is not the contrary views I see expressed here,
where one would buy on weak RS and sell into overbought conditions
AP, the plural of anecdote is not data. It would be as futile and unconvincing for me to ask you if you’d ever heard of a much, much, *much* richer guy named Buffet. His existence doesn’t mean trendfollowing doesn’t work, any more than Dennis’s means it does.
I take it you’re long GM.
Trend in GM is up — just broke above 50 and 200-day moving averages and is trading at a 6-month high. Huge expansion of volume.
what is the formula to calculate relative strength