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| Lesson 3: |
Wrap Up |
Reversals on RS Charts
My stocks RS chart is on a buy signal but it has reversed into a column of Os. What do I do?
RS charts are one of the primary tools we use to evaluate stocks. However it is important to
remember that RS signals and column changes do not necessarily indicate the direction of the
price of the stock. We also use other tools like the trend chart, Sector and Market Indicators
to help manage the trade. Significant deterioration in these other "tools" would suggest a
more defensive stance with the stock. There are many ways to play defense. Using options you
could sell calls, or buy protective puts. You could sell the position or a partial position.
What is important is that you recognize that with the deterioration of the supply and demand
relationship and the near term RS weakness demonstrates the probabilities are no longer in you
favor. If the attributes of the trend chart remain strong one would consider a pullback in the
RS chart as "normal". One would pay closer attention to all aspects of the stock's charts and as
long as other indicators remain strong and reward to risk ratios are appropriate, additional
positions may be considered.
A stock I am watching has negative RS but it has reversed to Xs. Can I buy it?
There is no one right answer. Provided the reward to risk ratio is appropriate, you can
initiate a position. The reversal up on the RS chart does indicate a period of out performance
but with the RS chart on a sell signal it may not last. Therefore be sure to maintain and
update your stop loss points. Do not ignore a reversal back to Os in this scenario. You
would be wise to consider the position a "trade" and manage it more aggressively from a risk
management standpoint.
Relative Strength has practical applications for both the investor and trader. For an investor,
buying and selling solely on chart patterns could lead to more turnover than an investor has
appetite for. Utilizing relative strength and trend charts can help define longer term trends
for a security; often the goal of an investor. For a trader, the size of your winners is
important and relative strength increases your probabilities of being successful in choosing
a market leader.
We will now test you to find
your comprehension of the subjects discussed in Lesson 3.
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