CHAPTER 4

Foundations of Relative Strength

This is a chapter I want you to pay particular attention to. In my opinion, it is the most important. Naturally, everything in this book comes together to form a total methodology, but relative strength is the key. In What Works on Wall Street (New York: McGraw-Hill, 1998), Jim O'Shaughnessy found that RS was a factor in all 10 of the top-performing strategies (that he tested). He also found that the worst strategy in his testing was buying stocks with the worst RS. All of our listed products, like the PowerShares DWA Technical Leaders Portfolio (PDP), are rules based using relative strength (RS) as the engine of the selection process. Once the rules are established, the program runs itself. To give you an idea of how this rules-based process has done, PDP ranked in the top 1 percent of all funds in its category in 2012 (through August) and ranks in the top 8 percent of all funds in its category on a three-year basis (through August 2012), according to Morningstar data.

I use RS in every portfolio I construct. In fact, in most cases, I use RS only in portfolios I construct. You see, the computer can easily compare and contrast millions of charts overnight without my lifting a finger. The days of doing everything by hand is over. We have been able to teach the computer what we know. All the computer needs to understand is X's and O's. It is unlike a bar chart or candlestick chart where each is updated every day no matter how inconsequential ...

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