Relative strength compares the performance of one asset to another over a period of time by taking the price of one and dividing it by the other. It provides context on whether an asset is undervalued or overvalued relative to its historical trading range compared to the other. Pairs trading strategies look for opportunities when two historically correlated assets diverge in their relative strength. Tools for analyzing relative strength include price ratios, relative strength ranks based on market performance, volatility ranks, and identifying bullish or bearish divergences in the price relative.

1. Relative Strength
Concept
CMT LEVEL - I

2. Relative Strength Concept
• Relative strength is a measure of the price trend of a stock or other
financial instrument compared to another stock, instrument or
industry.
• It is calculated by taking the price of one asset and dividing it by
another.
• For example, if the price of Ford shares is $7 and the price of GM
shares is $25, the relative strength of Ford to GM is 0.28 ($7/25).
• This number is given context when it is compared to the previous
levels of relative strength. If, for example, the relative strength of
Ford to GM ranges between 0.5 and 1 historically, the current level
of 0.28 suggests that Ford is undervalued or GM is overvalued, or a
mix of both.

3. Relative Strength Concept
•It is by comparing the relative strengths of two
companies that a trading opportunity, known as pairs
trading, is realized.
• Pairs trading is a strategy in which a trader matches
long and short positions of two stocks that are
perceived to have a strong correlation to each other
and are currently trading outside of their historical
relative strength range.

4. Relative Strength Concept

5. Tools for Relative Strength
Price Ratios
Relative
Strength
Ranks
Volatility
Ranks
Market Ranks
Divergence
Ranks

6. Price Ratios
• Relative strength is a ratio of a stock price performance to a
market average (index) performance. It is used in technical
analysis.
• It is not to be confused with relative strength index.
• To calculate the relative strength of a particular stock, divide the
percentage change over some time period by the percentage
change of a particular index over the same time period.
• The Price Relative indicator is simply the base security divided by
the comparative security.
• Price Ratio (Unadjusted) makes no such adjustment and simply
displays the raw ratio of closing price between two securities.

7. Relative Strength Ranks
• Relative Strength Rank Is Not Rsi , (or Relative Strength Index), where the
stock is compared against itself, other similar industries or sectors or
indexes
• This is a measure of price performance of the stock during the previous 12
months Against The Entire Market Irrespective Of Exchange.
• If we have a stock that has been ranked as 80 or better, that means that this
stock viewed from the perspective of price outperformed 80% of ALL other
common stocks in the entire database during the last year, (previous 52
weeks).
• As an example, clicking on "80+" means that you will only accept screens of
stocks which have 80 or greater relative strength. Conversely, if you were to
choose "<30" you would be looking for stocks which were performing worse
than 70% of the market.

8. Volatility Ranks
•Several of the tests which follow make reference to the
comparative volatility of the price movements of the
individual securities.
•A measure of volatility known as the coefficient of
variation was utilized in this study.
•The coefficient of variation is the ratio of the standard
deviation of a set of numbers to the arithmetic mean
of the set.

9. Market Ranks
•In Order to test certain techniques of market timing,
long-term (i.e., 26-week) historical market ranks were
included in the data file.
•The computation of these market ranks was relatively
simple. The 200 stocks in total were considered to be
representative of the entire market.

10. Market Ranks
• Each week, the sum of the 200 C/A26 ratios was determined
in order to indicate the market's performance over the
preceding six months.
•The market ranks would probably be about the same no
matter whether hindsight were used or whether some time
period prior to the period of this study were adopted as a
standard of dispersion of six-month market performance.

11. Bullish Divergence in the Price Relative
•A bullish divergence in the
Price Relative signals
relative strength during a
price decline. Stocks that
hold up the best during a
decline are often the
leaders when the market
turns around
•The chart below shows
DuPont (DD) with the Price
Relative (DD:$SPX).

12. Bearish divergence in the Price Relative
•A bearish divergence in the
Price Relative signals relative
weakness during a price
advance.
•Stocks that underperform on
the way up often lead lower
when the market reverses.
•The chart below shows
Mastercard (MA) with the
Price Relative (MA:$SPX).