Sector relative strength is a very important part of our work. Studies have suggested that anywhere between 75% to
80% of the risk in any particular stock is in the market and the sector. The economic forces that affect one stock
within a sector, most often affect the whole school of fish.
There are a number of different Point & Figure indicators we examine to determine whether supply or demand is in control
of a sector and one of those is relative strength based. Sector Relative Strength (RS) is a means of measuring how a
particular sector is performing compared with the market in general. At Dorsey, Wright & Associates, we have created
40 different broad sector indices. These are equal weighted indices and once an index is created, we can then create
a relative strength chart of that sector.
The relative strength calculation is essentially the same as a stock's relative strength calculation, merely substituting
the sector index price for the stock price. Each day we take the price of the DWA Sector Index and divide by the S&P 500
Equal Weighted Index. Multiply this by 100 and the resulting reading is plotted on a Point & Figure chart.
When evaluating a Sector Relative Strength chart, we look at it slightly different than a stock relative strength chart.
Because the sector is a basket of stocks, it typically moves slower than an individual name. Therefore, we will look
solely at the column of the relative strength chart as our guidance. If the Sector Relative Strength chart is
in a column of X's, that suggests the sector has positive relative strength and should likely outperform the market.
Conversely, if the Sector Relative Strength chart is in a column of O's, that would suggest the sector has negative
relative strength compared to the overall market and is likely to underperform.