In this video I show you how to apply relative strength investing strategies to your own portfolio to help you decide what stuff is best to be sold and how to find things that are truly worth buying.
TRANSCRIPT:
Okay, Mike Swanson here. Today, I wanna talk about relative strength investing strategies.
It’s a core component to learning technical analysis.
It’s one of the most important things I use in my own trading, my own investing. And I think everyone needs to know about it even though, the funny thing is, it’s hardly ever talked about on most stock picking websites. And even on CNBC, most of the time they just talk about what’s the hot stock of the day. And that is not what I’m speaking about. I’m not really trying to talk about chasing things at all. In fact, it’s quite the opposite. And I’m gonna show you how to use relative strength in order to find the right stuff to buy on dips and to sell on market rally stuff that’s likely to lead on the downside. So it’s a way to analyze your account periodically, figure out what you should get rid off and figure out what’s worth purchasing. And yes, with technical analysis, you use price action to determine what should be bought and what should be sold. And there’s many popular technical indicators to help you do this.
One of my favorites, for example, are the 20-day Bollinger Bands. I also use Daily Stochastics. There are dozens and dozens of indicators. There’s even a relative strength index indicator, RSI is the abbreviation for it. That is not what I’m speaking about in this video. This discussion on relative strength is not the RSI indicator. What I’m speaking about is very simple. It’s the relative strength ratio. It compares the price of one thing with the price of another by you creating a simple ratio. You take the price of X, divide it by the price of Y on any given day. So let’s say you’re looking at stock A, trading for $10, stock B trading for $5. That’s a ratio of two to one. But that those two prices are gonna change on a daily basis and you’ll be able to watch how this ratio goes up or down by tracking it on a daily basis and you plot that out on a stock chart.
Here’s an example. This is Disney up above on this chart, symbol DIS. On the bottom is the relative strength ratio. You can see today, it says 0.04. It’s created by dividing the share price of Disney with the number that the S&P 500 is trading at. And you can see that that ratio was around zero… It was around 0.02. The start of this chart, it’s at 0.04 right now. However, I want you to notice the key thing here. That ratio since 2015, since the summer of 2015, has been declining. What that means is that Disney shares have been trading weaker than the S&P 500. When the S&P 500 tends to go down, Disney goes down more. When S&P 500 goes up, Disney tends to go up less. This means Disney is not really a stock that you want to own and hold because of the situation it’s in. So on stock market rallies, Disney is a stock that really you would wanna sell. And you would wanna look at other holdings that you have during stock market rallies to see if they’re also lagging the S&P 500.
Because if they are, you wanna liquidate. You want to use those positions to raise cash reserves. And then when the stock market has its drops and dips, you can then deploy these cash reserves to buy the stocks, to buy the sectors that displays strong relative strength ’cause those types of investments tend to pay off the best on market rallies, and even can break away from the entire stock market itself and go up even if the stock market drops. That’s one of the key secrets to long-term investment success. It’s not just to be a momentum person chasing the fad of the moment, but to be able to buy things that go up even when the stock market is in a bear market and other people are losing money.
Let’s look at another example to show you this again. This is Apple from 2007 to today as I’m doing this video on September 12th. Yes, Apple was a great stock to own from 2007 up until the Summer 2015. Apple went from below $10 all the way up to close to $130. And Apple had incredible gains in this relative strength ratio. It rose during most of the time. However, in the summer of 2015, Apple started to report bad earnings. The iPhone market simply became saturated with competitors, and just about every person that wanted an iPhone bought one. The fad was ending. And insiders, if you look into it, actually started to dump Apple stock that summer and they’ve been doing it ever since, in this point in time as I’m doing this video. Now, look at the relative strength ratio. It made a double-top in 2015, it did not go through the high of 2012, and has been in a down trend ever since. And when the stock market has corrections and has declines, Apple tends to drop more than the S&P 500. And on the rallies, it tends to rally less. So in August, the S&P 500 made a new high, but Apple still remained well below its high the summer of 2015. And that means now, as I do this video, if the stock market goes lower between now and the end of the year, Apple will lead on the downside. Apple is resting right on its 200-day moving average while S&P 500 is above it, that’s a bad situation.
And that’s not the type of stock that you really want to hold. You want to be in the strong stocks that buck market declines, generally speaking, and go up more when the market goes up. There’s no point in owning Apple. So to recap, after big market rallies, you wanna reduce holdings in weak relative strength stocks and sectors, such as the exchange traded funds, that you may own in your brokerage account. It’s impossible to time exact tops and bottoms, so you just have to be happy to make money and then say, “Hey, this is time. I’m gonna reduce some holdings here or make some changes in my account.” And you do that periodically, and I think now is a good time to do it. Look through your stuff. Do you have positions that have beat the market this year? Or have they lagged the market? You probably got a mix of both. Get rid of the laggards, that’s what I would do. And prepare yourself because the opportunities to buy are after stock market declines, because they give you the opportunity to look and analyze the entire stock market to find out which sectors decline less than the stock market does, and shift money into them because those strong opportunities in such sectors and such stocks give you the chance to be in future market leaders.
Again, let’s think about Apple. Look at Apple in 2009, the stock market actually was following very substantially below the lows of 2008 and the first half of 2009, and Apple didn’t do that. Apple displayed powerful, strong relative strength, and the indicators showed that, and lo and behold, Apple came out of that big decline as a wonderful stock market leader to own. But it took the decline to be able to identify such a situation. Now Apple is in the opposite situation. So there’s very few stocks and sectors that go up for nine years as a market leader, but they can go up for three years, four years, five years, but you gotta find the right moments and you gotta have the cash on hand to be able to buy at the right time. Here’s another example of an entire sector. Biotech. Biotech also displayed strong relative strength in the first half of 2009. It bucked the trend of a declining S&P 500. Biotech, this is the BBH ETF, did not make new lows and the S&P 500 did, and like Apple, that was a sign that it was gonna emerge out of that last bear market as a market leader.
But now, that’s not the case. In fact, just like Apple, Biotech, the BBH ETF, has been a market laggard since the summer of 2015. It declined substantially from July 2015 to March 2016, it’s had a weak bounce. Even though the S&P 500 managed to rally to make a new minor high this year, Biotech was unable to do that at all, it traded worse than Apple did. In fact, it’s actually one of the worst performing sectors in the entire stock market this year. What that means is that Biotech is one of actually the most dangerous sectors right now to have money in. It’s lagging so poorly, so bad, that it’s vulnerable to substantial decline, to repeat the type of decline that occurred in the summer of 2015 for about six months from then on. So it’s a sector to avoid, while it was a wonderful sector to invest in in 2009. So think about this moment in time, analyze your positions, and personally I think that patience right now is the key thing in the market. I know if you turn on TV tonight, if you watch CNBC tonight, you’re gonna see stock picks suggestions. You’re gonna see people yell out, “Buy this. Buy that.” And usually, it’s whatever is up the most that day, but you’ve got to look at a bigger picture from just what happens on a single given day and use the relative strength ratio indicator to give you an idea of the picture for the past couple of years and be able to put in the context to today’s action into that big picture.
: And then I think if you do that, you’ll realize, “Hey, we’ve had a big stock market rally. Let’s get rid of my laggards. That way I can have some cash on hand, so when there is a pull-back, a decline, I’ll be able to shift into the stuff holding up that can become a future market leader.” And I’ll show you to end this, what has been one of the top performing sectors this year that had been one of the worst in the preceding couple of years is mining stocks. This is the HUI Gold BUGS Index for gold stocks. It doesn’t have the junior mining companies in it, but has the mid-tier and above ones. It’s pulling back right now. It’s in a little bit of a minor corrective phase, but the relative strength ratio has been trending up all year.
When it had peaked out in 2011, to decline, it bottomed out and began an up trend in 2016 to show us that on stock market dips, this is one of the sectors you’re gonna wanna look at and see how it looks and put some money into that. And we’re gonna get buying opportunities in mining stocks I believe this year and from then on. So exciting times. There’s always opportunities to do well in the markets, but it takes studying and being on top of the situations of what’s going on, and using technical analysis and incorporating that with the building blocks in it of the technical indicators. And I think one of the most important things to look at is relative strength investing strategies.
