Relative Strength Trading Explained

 Definition of Relative Strength Trading

(1) Select a list of K funds or stocks.

(2) Select the number (N) of things you want to hold at a time.

(3) Select the cut-off point (M), where K > M > N.

(4) Select the method of calculating relative strength.

Rank the stocks in the list, where the lower number is the higher rank. This means that the funds are ranked 1 through K.

Buy the top N funds.

When a fund is ranked below M, sell it and buy the top-ranked fund that you do not already own. It is possible to have a different method of ranking for the buy and sell decision. So you would sell when the sell rank falls below M, and buy based on the buy ranking list. You might also, in order to minimize the frequency of trading, insist on a minimum number of days to hold a thing.

 Ranking Method

There are (at least) the following ways to measure relative strength:

(1) Ranking of a collection of stocks or mutual funds - which of them have gone up the most over the last N days.

(2) Slope: fit a curve to the stock chart and take the derivative at the end point. The curve could be linear, quadratic, exponential, or something else. Your choice.

(3) Most Anchored Momentum (MAM): compute a short exponential moving average and a longer simple moving average. Take the ratio at the end point (present time). This was developed by Rudy Stephanel in an article in Technical Analysis of Stocks and Commodities.

(4) Exponential moving averages: a short one and a long one - take the ratio short to long at the end point.

(5) Accutrack: this is a proprietary indicator developed by Fasttrack. It compares two funds based on their recent returns. It can be used to give you a visual comparison of a fund to a money market account, for example. If Accutrack is positive, then the fund is a candidate to buy. Using Fasttrack, you can compare a set of funds, two by two, taking the top fund every time to compare it with the next fund on the list. In this way you can rank a list of funds.

The first method (1) is the weakest of all of the methods, since it does not take into account the direction of the thing you are trading. A stock that has moved from 50 to 100 and then back to 75 over the last 30 days, for example, will probably have a good ranking - after all it is still up 50%, and that will probably be better than most stocks. But a look at the chart might indicate that the stock is on a downward trajectory. Methods (2), (3), (4) and (5) attempt to measure the current direction of the stock, and so are likely to be more reliable.

There is an excellent presentation on MAM by Rudy Stefenel that also looks at other methods of ranking, and explains the rationale behind MAM.

FastBreak supports all of those ranking methods. So far as I can see, exponential curve fitting, MAM, and Accutrack are the most powerful.  However, MAM seems to be the best choice, particularly for stocks.

 Other Capabilities of FastBreak

Stops of various kinds.

Flow control - pre-conditions for buying a stock.

 Predictive?

This method does not try to predict a trend before it happens. It simply identifies a trend and hopes that the trend will continue long enough for you to make a profit and get out as the trend weakens.  It is like betting on the horse that is ahead, holding your bet so long as he is in the running, and then if he falls back, betting on the horse that has taken his place at the front. Of course, you cannot exactly do that at the racetrack.

 Now the question is how to find the best parameters for our system.  For that we use FastBreak Pro optimization