Relative Strength Analysis and Sectors

This is an extremely simple but effective charting tool. All you do is divide one market entity by another-in other words, plot a ratio of two market prices. When the ratio line is rising, the numerator price is stronger than the denominator. When the ratio line is declining, the denominator market is stronger. Consider some examples of what you can do with this simple indicator. Divide a commodity index (such as the CRB Futures Price Index) by Treasury Bond futures prices. When the ratio line is rising, commodity prices are outperforming bonds. In that scenario, futures traders would be buying commodity markets and selling bonds. At the same time, stock traders would be buying inflation sensitive stocks and selling interest-rate sensitive stocks. When the ratio line is falling, they would be doing the opposite. That is, they would sell commodities and buy bonds. At the same time, stock investors would be selling the golds, the oils, and the cyclicals, while buying the utilities, the financials, and consumer staples.

RELATIVE STRENGTH AND SECTORS 

Many exchanges now trade index options on various stock market sectors. The Chicago Board Options Exchange has the greatest selection and includes such diverse groups as automotive, computer software, environmental, gaming, real estate, health care, retail, and transportation. The American and Philadelphia Stock Exchanges offer popular index options on banks, gold, oil, pharmaceuticals, semiconductors, technology, and utilities. All of these index options can be charted and analyzed like any other market. The best way to use relative strength analysis on them is to divide their price by some industry benchmark such as the S&P 500. You can then determine which are outperforming the overall market (a rising RS line) or underperforming (a falling RS line).

Employing some simple charting tools like trend lines and moving averages on the relative strength lines themselves will help you spot important changes in their trend. The general idea is to rotate your funds into those sectors of the market whose relative strength lines are just turning up, and to rotate out of those market groups whose relative strength lines are just turning down. Those moves can be implemented either with the index options themselves or through mutual funds that match the various market sectors and industry groups.