The Nature of Strength-Following Markets

Rising strength-following markets are the best of times. If contrarian markets are a time of tilling and sowing, then strength-following markets are a time of harvest.

When both prices and the Spread are rising, the most profitable strategy is to buy and hold the strongest stocks. During these periods the trend is strong, and the best performing stocks attract a large and enthusiastic following. Avoid weak issues, even those which have built impressive bases. These stocks are likely to underperform stronger issues.

The signal feature of strength-following markets is that, on average, the higher the RS rank, the better the forward performance. The chart below shows a period during which the Spread rose. The black (lowest) line indicates the average performance of all stocks in the subject universe. The solid blue line shows the cumulative forward performance of the set of all stocks with an RS rank of one (1) or more. The dashed lines show the performance of increasingly highly ranked subsets of strong stocks. The higher the RS rank, the higher the forward performance.

Strength-Following Market

During strength-following markets, the higher the RS rank, the higher the forward performance.

By contrast, the performance of strong stocks during contrarian markets turns the above chart on its head. The chart below shows the performance of stocks with an RS rank of one or better during a contrarian period, as the Spread declines. Again, the benchmark is shown in black. The solid blue line is the forward performance of all stocks with an RS rank greater than one (1). Note that the average strong stock underperforms the benchmark. As RS increases, performance deteriorates further. The dashed lines show the performance of increasingly highly ranked subsets of strong stocks. The higher the RS rank, the lower the forward performance.

Contrarian Market

Ranking Stocks

When traders are in a strength-following mode, the most profitable information is the relative-strength ranking of stocks and groups.Focus on the strongest stocks within the strongest groups.

Once RS is determined for each target in the universe of interest, ranking by RS is easy. Shown below is the rank, from strongest to weakest, of 84 groups as of late August, 1999.

Because the benchmark is always equal to 100, groups above 100 are relatively strong, while those below 100 are relatively weak.

Group RS Ranking

Group	Rank
Semiconductors	138.65
Oil Drilling	131.01
Aluminum	130.70
Computer Systems	127.31
Oil Service	122.50
Paper	120.13
Telecomm Equip	119.88
Copper	119.18
Cellular Equip	117.07
Oil & Gas Explore	116.80
Bluechip Tech	115.31
Chemical	114.81
Asian Equity	114.50
Biotech	112.64
Steel	111.55
Oil – US Integrated	111.48
Pollution	111.42
Heavy Equip	111.10
App & Furn Mfg	110.25
Personal Credit	110.01
Manufacturing	109.54
Trucking	108.78
Utility Natural Gas	108.56
Natural Gas	108.44
Gaming	108.34
Cellular Service	108.24
Computer Network	108.05
International Oil	106.34
Retail Computers	105.97
Airfreight	105.88
Specialty Chem	105.82
Software	105.16
Radio Broadcasting	105.06
Utility Telephone	104.72
Diversified	104.49
Autoparts	103.03
Publishing	102.74
Newspapers	101.96
Gold	101.95
CATV	101.66
Retail Dept Stores	100.44
Shoes	99.78
Railroads	99.65
Building Products	98.45
Retail Bldg Prods	98.27
Media Diversified	96.90
Latin Amer Equity	96.46
Tobacco	96.33
Food Stores	95.55
Aerospace	95.50
Restaurants	94.86
Textiles Apparel	93.75
Home Builders	93.61
Money Cntr Banks	93.04
Food	92.45
Medical Prods	92.43
Comp Service	92.34
Retail Office Supp	91.58
Computer -PC	91.34
Utility Electric	91.22
Household Prods	90.59
Airline Regional	90.47
European Equity	90.21
REIT	90.02
Beverage	89.78
Retail Apparel	89.75
Mortgage	88.45
Brokers	87.46
Cosmetics	87.29
Retail Discount	87.10
Health Services	86.54
Bank Regional	86.28
Property Insurance	84.99
Thrifts	84.98
Drug Stores	84.33
Life Insurance	83.07
Long Distance Tel	80.99
Airlines	80.10
Hotels	79.84
Internet	79.30
Autos	77.97
Comp Peripherals	74.75
Drugs	74.52
Mfg Housing	66.25

While not necessary, it is nevertheless useful to normalize RS rank as a percent of maximum and minimum extremes. Entries equal to or greater than 100 (the benchmark) are compared to the maximum entry. The top group in the above list (Semiconductors) is, of course, 100 percent of the maximum entry. The next, Oil Drilling, has an RS which is 80 percent of the maximum, and so on.

Entries below 100 are compared to the minimum entry. To get this calculation right requires that 100 be subtracted from each entry before a comparison is made. So, for instance, the bottom group, Mfg. Housing, converts to a reading of -33.75 (66.25 minus 100). The next group up from the bottom, Drugs, converts to a reading of -25.38, and so on.Then divide each converted entry by the absolute value of the lowest in the list, in this case Mfg. Housing,to arrive at a percent of the minimum. For Mfg. Housing, divide -33.75 by 33.75 and then multiply by 100.The result is 100 (-33.75 / 33.75 * 100 = -100).

A similar calculation is carried out for all other groups with an RS rank of less than 100.The calculation for Drugs is: (74.52-100) / 33.75 * 100 = -75. The Drug group is only 75 percent as weak as Mfg. Housing.

Below is a truncated version of the RS ranking, converted to indicate percent of maximum and minimum RS (allow for rounding errors).

Normalized Group RS Ranking

(Partial)

Group	Rank
Semiconductors	100
Oil Drilling	80
Aluminum	79
Computer Systems	71
Oil Service	58
Paper	52
Telecomm Equip	51
Copper	50
Cellular Equip	44
Oil & Gas Explore	43
Bluechip Tech	40
–––	–––
–––	–––
–––	–––
Thrifts	-45
Drug Stores	-46
Life Insurance	-50
Long Distance Tel	-56
Airlines	-59
Hotels	-60
Internet	-61
Autos	-65
Comp Peripherals	-75
Drugs	-76
Mfg Housing	-100

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