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Lesson 3:	Part 1 - Relative Strength

Let's use the RS chart of IBM to illistrate the tenets of Market Relative Strength. Notice how this chart is much slower than the trend chart of IBM. One screen goes back over a decade and many of the marks designate months. If IBM were to trade in line with the market then there would be no movement on the RS chart. For example if IBM were to rally 10% and the Market (SPXEWI) were to also rally 10% there would be no change on the RS chart since there was no out performance by IBM. You will recall that a RS chart has 4 statuses. We will use the IBM Relative Strength chart to review those and how they are read. The first buy signal on the chart came in November 1996. A relative strength buy signal is given when a column of X's exceeds a previous column of X's. This is the strongest status since the RS chart is not only on a buy signal but also in a column of X's. A relative strength buy signal for IBM would suggest to us that we could expect to see the stock outperform the market on a relative basis for the next 18 to 24 months. The relative strength chart of IBM remains on a buy signal until October 2000. Now, the relative strength chart did not remain in a column of X's the entire time, there were pullbacks. But a reversal down into O's on the relative strength chart while still on a buy signal suggests more a breather or pause in the upward movement of the stock. These reversals serve to create an orderly pattern. During the time that IBM was on a relative strength buy signal, the stock was up 166% while the S&P 500 Equal Weighted Index was up 54.4%. The stock did in fact outperform the market as the relative strength chart would have suggested. In October 2000, the relative strength picture for IBM changed. After four years of positive performance, the relative strength sell signal (given when a column of O's exceeded a previous column of O's) suggested the stock should now begin to underperform the market. The relative strength signal in October 2000 is the weakest of the four status as the relative strength chart is not only a sell signal but also in a column of O's.

In taking the analysis a little bit further, if we couple the Point & Figure price chart of IBM in October 2000 with the relative strength chart we see that both were speaking loudly that supply was taking over. Not only had the relative strength chart moved to a sell signal but a look at the price chart shows that IBM had given a spread triple bottom sell signal at 99 and the trend was already negative. Clearly the odds were stacked against IBM. The relative strength chart of IBM remains on a sell signal at this time, thru the second quarter 2006. Since the relative strength chart of IBM moved to a sell signal, the stock is down 20% while the S&P 500 Equal Weighted Index is up 49.5%. The stock reacted just as the relative strength chart would have told us to expect. During the last six years that the relative strength chart has been on a sell signal, IBM has had bounces (when the RS chart moved to a column of X's) but those bounces tended to be short lived. As long as this RS condition persists, IBM is not a stock we would want to consider when there are thousands of other names with better relative strength charts.

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