Introduction to the Screening Method for Analysis of Relative Strength
Robert W. Colby, CMT
Over the very long term, covering multiple decades and including several major bull/bear cycles, Relative Strength is one of the best stock selection strategies. Relative Strength returned a 15.7% compound average annual growth rate over the past 21 years, thereby ranking second best out of 50 diverse investment strategies tracked since 1987 by Merrill Lynch Quantitative Strategy. Performance was measured against a universe of 1600 common stocks.
The Relative Strength Strategy is easy to understand: buy and hold only the strongest stocks. When a stock slips enough so that it is no longer among the strongest, sell and replace it with whatever is the new strongest.
With the computerized screening method’s predefined criteria programmed into a computer, any financial instrument can be quantitatively measured and ranked, quickly and objectively, against many thousands of competing instruments. For example, the entire universe of all stocks, all futures, all commodities and all currencies can be efficiently ranked form best to worst relative strength performance.
In the late 1960's, Robert A. Levy, Ph.D., and Charles D. Kirkpatrick worked together on a variety of experiments in technical forecasting. Their relative strength model, published continuously since 1982, has outperformed the S&P 500 by more than four to one. The model ranks 5,000 stocks each week by relative strength, from strongest to weakest. Every stock’s recent performance is compared against the whole universe of stocks, over a constant, pre-defined specific time period. Specifically, the model divides the closing price each Thursday by the trailing 26-week moving average of those weekly prices. Next, the model ranks the ratio for each stock against the comparable calculations for all other stocks, forming a list of stocks ordered by performance from strongest to weakest. The top percentiles of the list represent the top performing stocks, those with the highest relative strength. Conversely, the bottom percentiles of the list represent the worst performing stocks, those with the lowest relative strength. The midpoint of the list shows the median past performance. See: Levy, Robert A., Ph.D., “Relative Strength as a Criterion for Investment Selection,” the Journal of Finance, December 1967, 22, pages 595-610. See: Narasimhan Jegadeesh and Sheridan Titman, “Returns to Buying Winners and Selling Losers: Implications