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1. SECTION II
Asset
Relationships

2. CHAPTER 11
A Unique Way to
Visualize Relative
Strength

3. Relative Strength Analysis
3
- Relative strength is a type of momentum investing used by technical analysts and
value investors.
- It consists of selecting investments that have been outperforming their market or
benchmark.
- Relative strength investors assume that the trend of outperformance will continue.
If the trend reverses, their investment will likely perform poorly.
▪ The formula to calculate Relative Strength is simple:
▪ RS = Price of security A / Price of security B

4. Relative Strength Analysis
4
- When the RS line moves up the
Consumer Staples sector is
outperforming the broader market
and should be "overweight" in
portfolios.
- When the RS line is moving down
the Consumer Staples sector is
under performing the broader
market and should be
"underweight".

5. Relative Strength Analysis
5

6. Relative Rotation
Graph

7. RRG – Relative Rotation Graphs
7
- Chartists can use RRGs to analyse the relative strength trends for several securities
against a common benchmark, and against each other.
- RRGs use four quadrants to define the four phases of a relative trend. True
rotations can be seen as securities move from one quadrant to the other over time.
- Construction of Relative Rotation Graphs, look at the two main inputs: JdK RS-Ratio
and JdK RS-Momentum.
- RS-Ratio is an indicator that measures the trend for relative performance. Similar to
the price relative.
- RS-Ratio uses ratio analysis to compare one security against another (usually the
benchmark). It is designed to define the trend in relative performance and measure
the strength of that trend.

8. RRG – Relative Rotation Graphs
8
- This indicator reflects an uptrend
in relative performance when
above 100 (relative strength) and
a downtrend in relative
performance when below 100
(relative weakness).
- The further the indicator is above
100, the stronger the uptrend in
relative performance. The further
the indicator is below 100, the
stronger the downtrend in
relative performance.

9. RRG – Relative Rotation Graphs
9
- Momentum changes course before the trend
actually reverses.
- RS-Momentum is an indicator that measures
the momentum (rate-of-change) of RS-Ratio. As
a momentum indicator, it leads RS-Ratio and
can be used to anticipate turns in RS-Ratio.
- Typically, RS-Momentum crosses above 100
when RS-Ratio is forming a trough and starting
to move up. Conversely, RS-Momentum crosses
below 100 when RS-Ratio is forming a peak and
starting to move down.

10. RRG Construction
10
- Relative Rotation Graphs are plotted on a
standard scatter-plot canvas with an x-axis
(horizontal) and y-axis (vertical). The JdK RS-Ratio
indicator is the input for the horizontal axis, and
the JdK RS-Momentum indicator is the input on
the vertical axis.
- These axes cross at 100 to create four relative
performance quadrants. The Relative Rotation
Graph simply plots RS-Ratio and RS-Momentum
values for each symbol. If the symbol universe is
the nine sector SPDRs and the S&P 500 is the
benchmark, we will see nine points on the
Relative Rotation Graph (RRG) and each point
represents that particular sector's RS-Ratio and
RS-Momentum value.

11. RRG Construction
11
▪ Relative Rotation Graph is shown above with four possible combinations. Let's
assume we are using the nine sector SPDRs as our universe and the S&P 500 as
the benchmark.
▪ A sector is in the leading quadrant (green) when RS-Ratio and RS-Momentum are
above 100 (+/+). A positive RS-Ratio indicates an uptrend in relative performance
and positive momentum means this trend is still pushing higher.
▪ A sector is in the weakening quadrant (yellow) when RS-Ratio is above 100, but
RS-Momentum moves below 100 (+/-). A positive RS-Ratio indicates an uptrend
in relative performance, but negative momentum means this uptrend is stalling or
losing power.
▪ A sector is in the lagging quadrant when RS-Ratio and RS-Momentum are both
below 100 (-/-). A negative RS-Ratio indicates a downtrend in relative
performance and negative momentum means this downtrend is still pushing
lower.
▪ A sector is in the improving quadrant when RS-Ratio is below 100, but RS-
Momentum moves above 100 (-/+). A negative RS-Ratio indicates a downtrend in
relative performance, but positive momentum means this downtrend is stalling or
potentially reversing.

12. RRG Construction
12
- The chart below shows the nine sectors with 12-
week trails and we can see them rotating from
one quadrant to another. Each point marks one
week.
- At the top, XLF moved from improving to leading.
At the bottom, XLU moved from weakening to
lagging. The blue line shows XLP moving from
weakening to lagging, and then from lagging to
improving.
- The improving quadrant means RS-Momentum
moved above 100, but RS-Ratio remains below
100. XLY moved into the leading quadrant when
both RS-Ratio and RS-Momentum were above
100.

13. RRG- Interpretation
13
- Rules-of-thumb you may want to follow:
- RS-Ratio is more important than RS-Momentum. RS-Ratio is also the preferred metric for
ranking a group of symbols.
- The leading quadrant (green) is first, the improving quadrant (blue) is second, the weakening
quadrant (yellow) is third and the lagging quadrant (red) is last.
- The rotational patterns are not always perfectly circular and will not always rotate through all
four quadrants in a clockwise manner. These are, after all, financial markets driven by fear and
greed.
- A historical trail can remain on the right side of the RRG when there is a strong uptrend in
relative performance. This means RS-Ratio is holding above 100, and RS-Momentum is
fluctuating above/below 100.

14. RRG- Interpretation
14
- a historical trail can remain on the left side of the
RRG when there is a strong downtrend in relative
performance. This means RS-Ratio is holding
below 100, and RS-Momentum is fluctuating
above/below 100.
- a cross from the left half to the right half signals
a new uptrend in relative performance.
- Symbols in the leading quadrant should be on
your buy list because they show relative strength.
- Symbols in the weakening quadrant should be on
your watch-list for deterioration.
- Symbols in the lagging quadrant should be on
your avoid list because they show relative
weakness.
- Symbols in the improving quadrant should be on
your shopping list as potential buys.

15. Different Users
15
▪ Portfolio managers underweight positions in sectors that are (moving) in(to) the
lagging quadrant and look for overweight opportunities in sectors which are
(moving) in(to) the improving quadrant and getting closer to leading.
▪ Pair traders, on the other hand, might be interested in looking for buying
opportunities inside the lagging quadrant and selling opportunities inside the
leading quadrant. Especially when the tails have started to turn up or down to
suggest that the relative move might be coming to an end or at least slowdown.
▪ Market makers whose job it is to ―make a market‖ in a group of stocks, often a
(sub-)sector, use Relative Rotation Graphs to keep an eye on the relative behavior
of all the stocks in their universe and spot anomalies or outliers in their early
stages.
▪ Options strategists, whose task is to generate hedging strategies to adequately
protect client portfolios, use Relative Rotation Graphs to identify the securities in
the portfolio that are more likely to underperform and require more aggressive
puts to protect the investments.

16. RRG Quadrant
16
▪ RRGs, he or she immediately latches onto the idea of buying securities that are
improving and selling those that are weakening
▪ The analyst can also review how significant the rotations are (i.e., If a security is in the
Leading quadrant, what is the probability that it will rotate into the Weakening
quadrant?).
▪ This was tested using 20,000 rotations of large-cap U.S. stocks. Table 15.3 shows the
results of the tests.
▪ when a security is in a Leading or Lagging quadrant, there is at least a 90% probability
that it will rotate around to the next quadrant.

17. RRG Angles
17
▪ RRG Angles‘ functionality makes it
possible to perform granular
analysis of buy and sell signals at
different positions on the RRG.
▪ It was important to expose the
angular position of the security on
the RRG chart and then to define
rules based on those angles.
▪ This was done by considering the
RRG as a compass with zero
degrees (North) straight up and 90
degrees (East) to the right.

18. RRG Velocity
18
▪ RRG-Velocity is calculated by measuring
the vector difference between the
observations.
▪ “Hook turns” that resulted in an almost
180-degree change in direction of the
security—were rare when the distance
between the observations on the RRG
was larger than normal.
▪ Higher velocity allows the analyst to see
that there should be no change to the
relative trend of the security.
▪ AAPL‘s final observation has a velocity of
0.63, while it had a velocity of 0.16 prior
to the hook turn. The lower velocity gives
the analyst a clue that a hook turn is
possible.

19. RRG Heading
19
▪ The final derived indicator came from an observation that even when
securities do small rotations on either side of the vertical axis, absolute
performance seemed to be highly correlated to the direction of the arrow.
▪ The direction of the arrows was an early indication of the relative
outperformance that was starting.
▪ RRG Heading uses the compass as introduced with RRG AnglesRRG
Heading uses the previous observation on the tail as its anchor and
measures the ―heading on the compass between the previous and the
last observations on the tail.
▪ This means that a northeast heading can occur in any of the four
quadrants on the
▪ RRG. The RRG Heading functionality allows for the quantitative analysis of
certain moves and rotational patterns on the Relative Rotation Graph.

20. Combining RRG Heading and Angles
20
▪ Table 15.4 shows an example of how these derived RRG indicators can add value to
a Relative Performance based strategy. test results are calculated from the S&P
500 member companies from 2001 to 2009
▪ It is interesting to note that the highest probability of gain, and the highest returns,
occurred when securities were classified as Lagging. This may be an endorsement
of buying when a security has been beaten down.

21. Combining RRG Heading and Angles
21
▪ Table 15.5 contains two extra tests. The first is that we only take a signal if the
security is in the Lagging quadrant and is heading northeast. The second set of
results also add RRG Distance as a condition to only select the securities that have
higher potential Alpha.

22. RRG CONCLUSION
22
▪ RRG can (also) be thought of as a relative mean reversion
indicator. The rotation confirms that a Lagging security will
eventually rotate around and become Leading again.
▪ Since mean reverting signals are short term by nature, they
could be used as a timing indicator in longer-term trend
following strategies.
▪ RRG journey is a great example of how quickly a brand-new
visualization tool has gone from an idea to reality, and then
leaped from being just a visualization to a quantitative input
to a set of stand-alone and hybrid strategies.

23. Weights on RRG
23
RRGs are often thought of as being an open or a closed universe.
▪ An open universe is one where only some of the stocks are
included or different asset classes are being compared. An
open universe RRG is still valid, but one cannot be sure if the
relative trend is because of the security or an external
influence on the benchmark that is not seen on the RRG chart.
▪ In a closed universe, any security that is going to influence the
value of the benchmark is on the chart, and its effect on the
RRG is visible. It means that all the securities on the RRG will
be in balance around the center of the chart since they are all
contributing to the value of the benchmark.

24. Points to be Remember
 Relative strength is a strategy used in momentum investing and in
identifying value stocks.
 It focuses on investing in stocks or other investments that have performed
well relative to the market as a whole or to a relevant benchmark.
 Chartists can use RRGs to analyze the relative strength trends for
several securities against a common benchmark, and against each other.
 RS-Ratio is an indicator that measures the trend for relative
performance. Similar to the price relative.
 RS-Ratio uses ratio analysis to compare one security against another
(usually the benchmark). It is designed to define the trend in relative
performance and measure the strength of that trend.
 RS-Momentum is an indicator that measures the momentum (rate-of-
change) of RS-Ratio. As a momentum indicator, it leads RS-Ratio

25. Points to be Remember

26. Points to be Remember
 The RRG Heading functionality allows for the quantitative analysis
of certain moves and rotational patterns on the Relative Rotation
Graph.
 Higher velocity allows the analyst to see that there should be no
change to the relative trend of the security
 RRG Angles‘ functionality makes it possible to perform granular
analysis of buy and sell signals at different positions on the RRG.
 RRGs are often thought of as being an open or a closed universe.
 Open Universe is one where only some of the stocks are included or
different asset classes are being compared.
 Closed universe, any security that is going to influence the value of
the benchmark is on the chart, and its effect on the RRG is visible.

27. Thanks