These are incredible times to be able to trade the markets. Yesterday my top stock pick for August soared. The stock has been one of the best performing stocks though since the start of the year. What is making it go up so much is that it is a small cap mining stock and gold itself is just going up and up. Yesterday gold went up $50 dollars to close decisively above $2000 for the first time ever and is up again this morning in pre-market action.
Today I want to talk about what I consider to be my most important technical analysis indicator and how to use it the right way. It is the relative strength indicator which compares the action of a stock or ETF to the S&P 500. When this indicator rises it means that what you are looking at is outperforming the stock market.
Generally speaking if you want to beat the markets then you want to buy what is already beating the markets! You win by getting into winning stocks. Now this indicator is a simple ratio dividing the price of X by Y. So for example in this chart of the most popular gold ETF, GLD, the indicator is at the bottom of this chart (GLD: SPY). When the indicator goes up then X is outperforming Y.
This indicator has been trending up showing that gold has been outperforming the stock market since October of 2018. One of the biggest factors in what I decide to invest in and trade is by looking at relative strength. The relative strength of the sector that a stock is in is it’s most important factor.
This does not mean simply buying something because it is going up and soaring though! Not at all. What you want to see is something show powerful relative strength not just when the stock market goes up, but when the stock market falls.
You want to buy into stocks of sectors that don’t fall as much as the stock market does when it drops. As you can see this GLD ETF did just that by falling less than the stock market did when the stock market crashed in March. In fact this relative strength indicator for GLD jumped up in March!
That is the key secret to using the relative strength indicator the right way – usually the sectors and ETF’s that hold up when the stock market drops become future long-term market leaders.
A lot of people that trade on Robinhood bought into airlines and stocks that just completely crashed in March. These stocks went up a lot in April, but have since been doing nothing while gold and mining stocks have been soaring and soaring.
The difference is these popular crashed stocks fell worse than the stock market did in March. They displayed AWFUL relative strength and really just bounced mainly on short covering. The things to buy and hold that are still doing great are the things that displayed strong relative strength. These are the power stocks and plays.
This is why gold, silver, and the mining stocks are so strong now. It’s a move that is just going to continue.
Consider this – personal income data that came out Monday shows that the US savings rate has increased to 25% from 9%. High income people are saving money building their savings, but they can’t draw any interest from the bank. When the economy gets more back to normal many of these people will spend to help drive inflation. But from the investment standpoint many of these people are in bonds and CD’s and when inflation starts and rates remain at zero and their CD’s expire they will throw their money into gold as a safe haven and because it is now the hottest thing in the financial markets. This is something to get ahead of.
But the key concept to remember here is that relative strength is the most important indicator for determining whether something will be the type of investment that can beat the stock market going forward.
If you want to know about my trading and investing strategies then grab my book Strategic Stock Trading. You can get it on Amazon by clicking here.
-Mike
