Relative Strength and Individual Stocks, Top-Down market approach

RELATIVE STRENGTH AND INDIVIDUAL STOCKS

Investors have two ways to go at that point. They can simply rotate their funds out of one market group into another and stop there. Or, if they wish, they can continue on to choose individual stocks within those groups. Relative strength analysis plays a role here as well. Once the desired index has been chosen, the next step is to divide each of the individual stocks within the index by the index itself. In that way, you can easily spot the individual stocks that are showing the greatest relative strength. You can purchase the stocks showing the strongest ratio lines, or you can buy a cheaper stock whose ratio line may just be turning up. The idea, however, is to avoid stocks whose relative strength (ratio) lines are still falling.

TOP-DOWN MARKET APPROACH

What we've described here is a top down market approach. You begin by studying the major market averages to determine the trend of the overall market. Then you select those market sectors or industry groups that are showing the best relative strength. Then you select individual stocks within those groups that are also showing the best relative strength. By incorporating inter-market principals into your decision making process, you can also determine whether the current market climate favors bonds, commodities, or stocks which can playa role in your asset allocation decisions. The same principles can also be applied to international investing by, simply comparing the relative strength of the various global stock markets. And, finally, all of these technical tools described herein can be applied to charts of mutual funds as a final check on your analysis. All of this work is easily done with price charts and a computer. Imagine trying to apply fundamental analysis to so many markets at the same time.