Section Ten: Comparative Market Analysis

Explain two major issues in relative strength analysis

Relative trend can be opposite to absolute trend: A security may be in an absolute downtrend, but if the benchmark is trending down more steeply, the relative strength line will be in an uptrend (and vice versa). Trading strategies that rely on relative strength should always consider the trend of the benchmark as well.

Numerical relative strength values are meaningless: Due to the nature of the calculation, the values cannot be used to rank a universe based on relative strength because they have no universal meaning. The output depends entirely on the prices of the securities being considered.

Compare and contrast the JdK RS-Ratio and JdK RS-Momentum

JdK RS-Ratio: Is a normalized measure of relative trend that measures the trend of relative strength itself. Values are centered at 100, with values above 100 showing outperformance and below 100 showing underperformance. It is the most important and influential numerical measure in relative strength analysis and shows the current state of relative performance.

JdK RS-Momentum: Uses a rate of change approach to measure the direction and pace of the relative trend. Values are also normalized and centered at 100. It acts as a leading indicator, providing early warning signals of pending changes in the RS-Ratio. When RS-Momentum drops below 100, RS-Ratio tends to peak and decline; when it crosses above 100, RS-Ratio tends to form a trough and rise.

Together, these indicators provide a complete picture of both the current relative strength state (RS-Ratio) and its likely future direction (RS-Momentum).

Outline the roles of JdK RS-Ratio and JdK RS-Momentum as building blocks for the RRG chart

The JdK RS-Ratio and JdK RS-Momentum serve as the fundamental building blocks for constructing Relative Rotation Graphs (RRGs). The JdK RS-Ratio is plotted on the horizontal axis and represents the relative trend of securities against their benchmark, with values above 100 indicating outperformance and below 100 indicating underperformance. The JdK RS-Momentum is plotted on the vertical axis and measures the rate of change in the relative trend, serving as an early warning indicator.

Together, these two measures create a scatter plot where securities are classified into four quadrants: “LEADING” (strong ratio and momentum), “WEAKENING” (strong ratio but weakening momentum), “LAGGING” (weak ratio and momentum), and “IMPROVING” (weak ratio but improving momentum). This visualization allows analysts to track the relative performance of multiple securities simultaneously and identify their rotation patterns around the benchmark’s center point of (100,100).

Illustrate the role of the benchmark in the RRG chart

The benchmark serves as the anchor point of the RRG chart, positioned at the intersection point (100,100) where the axes meet. All securities in the universe are scaled against this same benchmark, making it the central reference point from which relative performance is measured.

When a security has a JdK RS-Ratio value of 100, it means it is moving in perfect harmony with the benchmark. Values above 100 indicate outperformance; values below 100 show underperformance. Similarly, the vertical axis (JdK RS-Momentum) uses 100 as the centerpoint, with values above showing stronger momentum and values below showing weaker momentum.

This benchmark-centered approach allows analysts to quickly visualize how all securities in their universe are performing relative to the benchmark and to each other.

Diagram the ideal sequence of rotation for securities in the RRG chart

The ideal sequence of rotation follows a clockwise pattern through four quadrants:

1. Starts in the “LEADING” quadrant (top-right) where securities show both high RS-Ratio and RS-Momentum

2. Moves to “WEAKENING” quadrant (bottom-right) as momentum begins to decline while still maintaining relative strength

3. Transitions to “LAGGING” quadrant (bottom-left) when both momentum and relative strength are weak

4. Moves to “IMPROVING” quadrant (top-left) as momentum begins to increase while relative strength is still weak

5. Returns to “LEADING” quadrant as both momentum and relative strength become strong again, completing the cycle

Research shows there is at least a 90% probability that securities in the “LEADING” or “LAGGING” quadrants will rotate to the next quadrant in this clockwise sequence.