Relative Strength - Not to be Confused With
the RSI
Forex
Articles - Technical Analysis
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Introduction
Relative Strength sits somewhere in the overlap between technical
and fundamental analysis; the calculation involves price and can
be plotted on a chart and the results can act as evidence of an
instrument’s current fundamental position. It is not to be
confused with the Relative Strength Index (RSI), which is a momentum
based technical oscillator.
Definition
We can define relative strength as a measure of how one instrument
compares to another, based on price. It is calculated by dividing
the price of one instrument with that of another over the same
period of time. This ratio can then be plotted on a simple line
graph to aid visual comparison.
This form of analysis is extremely
popular amongst stock traders and investors who can use the ratio
to identify the highest performing sector in any market, the
highest performing stock in any sector or even the nation with
the highest performing equity market on the global stage. One
form of common analysis is to compare a single stock to a market
wide benchmark such as the S&P500. Markets
and sectors with the highest relative strength are, in theory,
most likely to contain and yield the stocks with the greatest near
term investment potential. Of course relative strength is just
one tool in a toolbox and cannot be used to complete an entire
analysis project.
Use in the Forex and Commodity Markets
The use of Relative Strength is not as widespread in the forex
and commodity markets due to the fact that there are far fewer
instruments to trade and there is no benchmark index (the exception
to this rule is the Dollar Index). Therefore the method used
to apply relative strength analysis has to be slightly modified.
For forex, it may be useful to check the relative strength of
a number of currencies against one single currency. For example
you could compare the Euro, Pound, Yen, Swiss Franc, Australian
Dollar etc against the US Dollar to find the strongest performing
currency, or compare the EURUSD, GBPUSD etc to the Dollar Index.
This may be useful if you believe the US economy to be weak and
you wish to verify your fundamental research of other world economies
and highest potential returns when selling dollars. If you were
to compare the EURCHF, GBPUSD and the CHFJPY you could identify
the ‘strongest performing pair/ cross’ but not the
strongest currency because you are involving multiple currency
variable and comparisons are therefore completely out of context.
In terms of the commodity market there are more clearly defined
sectors in which to identify the best performers. These are: precious
and base metals, agricultural, oil and energy. You can apply relative
strength analysis to each commodity within these categories to
find the strongest performer. Once again though you will have to
compare each commodity to the others in that category rather than
a benchmark index.
Cross Market Analysis is Possible
Although we have mentioned that it is fairly pointless conducting
relative strength analysis on the GBPUSD vs the CHFJPY to identify
the strongest currency, cross-market comparisons are possible
and can be said to hold analytical value. As a crude form of
comparison stocks and bonds are often compared in this fashion
to answer the question: “Would you have made more from
investing in Stocks or Bonds over the last five years?”
Forex
Articles - Technical Analysis
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