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Sector
Relative Strength is a great tool to use when trying to determine
which sectors are outperforming the market. Given the fact that
the Sector is one of the greatest contributors to price fluctuation in
a stock, it is extremely important to determine its relative
strength. Those sectors exhibiting positive relative strength
(ones in a column of X's on their RS chart) are the ones to focus
on. We covered this topic in Lesson 3 but want to revisit it here.
Relative Strength is a term we
use extensively and place great importance. Many of you are very
aware of its definition and importance pertaining to stock selection,
but sector relative strength is a vital component when determining which sectors are likely to perform the best. During times of market uncertainty, Sector
RS takes on a particularly significant role. It is at these times
that you should be paying close attention to those sectors which
are exhibiting strong relative strength - that is, are showing
that they are "out performing" the market.
Sector Relative Strength measures
how a particular sector is doing compared to the market in general.
The Relative Strength calculation is simply done by dividing the price of the sector by the price of the
S&P 500 Equal Weight (SPXEWI), and then multiplying by 100.
Formula:
(Sector Price / SPXEWI)(100)= Sector RS
This number is then plotted
on a point and figure chart. When evaluating Sector RS, what is most important is the
most recent column on the RS chart.
When a sector index reverses
up into a column of X's on its RS chart, we consider that a "Buy"
signal.
When a reversal up occurs,
it is a sign that you should consider initiating positions in this group.
Don't forget that there are other factors to consider such as risk in the general market and the
chart of the individual stock. A reversal down on the sector RS chart is considered a negative and
this would not be a sector to consider intiating positions in. If long stocks in these sectors it
is time to evaluate them and make sure that appropriate stop loss points are in place.
Sector Relative Strength can be computed on a variety of different indices. At Dorsey, Wright & Associates
we create equal dollar weighted indices on the following areas for the specific purpose of calculating
Sector Relative Strength.
- DWA Sectors (40 in all)
- Broad Economic Sectors (10 in all)
- Economic Sectors (32 in all)
- Sub-Sectors (49 in all)
- Mini-Sectors (34 in all).
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