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The Visual Investor: How to Spot Market Trends, Second Edition by JOHN J. MURPHY

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CHAPTER 9
Relative Strength and Rotation
The idea of using relative strength analysis was introduced in Chapter 7 to show how to spot which asset classes were moving into a leadership role and which were lagging behind. That chapter concentrated on relative performance between bonds, stocks, commodities, and foreign stocks. It also showed that commodity-related stocks were top performers in 2007. Chapter 8 expanded the use of relative strength to show which market groups were market laggards during 2007. Whether one is dealing with asset classes or market sectors, the principle of relative strength is the same. That is, to invest in asset classes or sectors that are showing the best relative strength, and to avoid those displaying relative weakness. The ability to plot relative strength lines (or ratios) makes it relatively easy to track trends in relative performance and to spot when trend changes are taking place. The goal of this chapter is to expand even more on the use of relative strength analysis, and to show how flexible a tool it can be in the hands of the visual investor.

USES OF RELATIVE STRENGTH

Relative strength is an extremely simple but powerful tool. It simply compares how one asset is performing relative to another. This is accomplished by constructing a ratio between two competing assets. In other words, one asset is divided by another. The resulting relative strength (RS) line is then plotted along with the respective price chart. In Chapter 7, we showed ...

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