Trading Guide: How to spot outperformers and underperformers in markets using Relative Strength? Gaurav Bissa decodes!

Many technical studies discuss the quantitative part of trading, that is when to buy or sell an instrument. While that is indeed very important, the qualitative part is equally significant.

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This is answered by Relative Strength. This study is completely different from the relative strength index. 

Gaurav Bissa, Vice President at Trustline Securities decides how Relative Strength or RS helps us to identify expected outperformers and underperformers:

The benchmark used is Nifty and all the sectors are measured against it to identify the strongest sector(s).

This involves simple division of a particular sector and Nifty index. For example, the price of Nifty Metal is divided by the price of Nifty50, i.e, 5822/17000 which is 0.34.

This ratio is plotted on a graph against time, just like normal graphs. Many free websites and software provide such charts.

The normal technical tools and studies are then applied on ratio/relative strength charts to ascertain whether the ratio will go up or down.

In a nutshell we are trying to identify the outperforming sectors as the ratio will go up when the numerator, which is any particular sector, goes up faster as compared to the Nifty index. One needs to repeat this exercise with all the sectors available.

Once the outperforming sector is identified we repeat the same process to identify outperforming stock in that particular sector.

Continuing the example of the Nifty metal index one needs to divide the price of every stock in the metal index with the Nifty metal index as in this case we benchmark the sectoral index for measuring the outperformance.

For example, the price of Tata Steel is divided by the price of Nifty metal, ie, 1205/5822 which is 0.20. We will now study this ratio chart to check whether the ratio can go higher or not.

This will be possible once Tata Steel moves up faster compared to the Nifty Metal index. This particular process is repeated for other metal stocks to arrive at a small list of stocks which are expected to outperform

Final step is to check the price chart of these identified stocks to generate buy entries. In this case we will check the price chart of Tata Steel and look for an optimal buying level using various technical indicators and studies.

By repeating this exercise, one increases the chance or probability of having a winning trade as we have identified strongest stock from strongest sectors. This is an interesting top-down approach in technical analysis

(Disclaimer: The views/suggestions/advices expressed here in this article is solely by investment experts. Zee Business suggests its readers to consult with their investment advisers before making any financial decision.)