A client asks: “How do you select the relative strength stocks? Do you check one by one or do you have a tool?”
One of the best ways to find relative strength trading candidates is to look for actively traded stocks which exhibit a distinctive pattern of higher highs and higher lows in their 1-3 month chart patterns when compared against the major indices. Arguably the best high-probability relative strength set-up for a trade is to look for such patterns following a decline in the S&P 500 Index (SPX). When the SPX has made a series of lower highs and lows over, say, a 1-2 month period you will often find individual stocks that have made higher highs and lows during the same period. These stocks normally reflect insider buying, since typically only the “smart money” is savvy enough to purchase stocks in a broad market downtrend. The assumption behind this pattern is that informed traders are “in the know” and expect the stock to rebound with a market-beating performance once the broad market decline bottoms out and reverses.
A good example of a relative strength stock in recent months is EPAM Systems (EPAM), which in two different instances maintained its relative strength position versus the S&P during market pullbacks. The first such instance was in the May-June period when the SPX made lower highs and lows while EPAM made higher highs and lows. More recently, EPAM made higher highs and low during the August broad market pullback, which presaged its strong performance in September.
A fast way of checking for relative strength is by simply going to Bigcharts.com and typing in the stock symbol (say for IBM) and then selecting the "Compare To" button. This provides a pull-down menu and you can either select an index for comparison (in this case the S&P 500) or else type in a symbol of the stock, ETF or index of your choice). The chart shows the price line of IBM compared against that of the SPX (or whichever symbol you select). If the stock's price line is above that of the SPX, then you can automatically see that it's in a relative strength position -- especially if it has been outperforming the index for a period of several weeks or months.