Hi friends and welcome to this podcast by Angel One. Today, we are going to look at a simple and powerful indicator which is very popular in technical analysis. But before that, let’s check out Rini’s story.
Rini was looking to invest a chunk of the lump sum payment she had received after completing a big project. She did some research and came up with three companies, which had been growing massively during the last decade. She went to her friend Vikas who runs his own investment advisory firm.
When she told Vikas about her plans, this is what he told her after a short pause: “Why would you invest in these companies, which are currently performing worse than what I am going to suggest you?”
Rini was shocked - she asked him as to how he could figure that out in 20 seconds!
So friends - can you guess what Vikas did?
Don’t worry - while you figure out, let’s talk about the Relative Strength comparison indicator.
Relative Strength Comparison or Relative Strength comparative, abbreviated as RSC, is an indicator that measures the performance of a security, in comparison to the performance of another security or index.
Sounds simple right?
Indeed - it is very easy to calculate the value of RSC indicator. For this, all you need to do, is to divide the price of one security by another security or index.
The formula is very simple - but let’s see which security goes on the numerator, and what goes on the denominator, and why.
Imagine a case where you are conflicted about investing in two companies within the same sector. Let’s assume automobile. You want to invest in company A, but company B seems an equally good alternative.
Basically, you want to compare company A’s performance with company B’s performance in the market.
This is the key to understanding the RSC indicator. The security whose performance you want to measure goes on top. And, the security against which you want to benchmark its performance against, goes in the denominator.
So far, so good.
Now, you can also consider the index you are trading at as your benchmark. In this case, if you want to assess a share’s performance with respect to the overall index or the market, the you simply need to divide that share’s price with the index’s price.
The point to pay attention to here, is that the value of RSC may be very small, or very large. But it’s absolute value doesn’t give us much. The real game begins when you plot RSC values for 2 securities over a period of time.
Consider an example where we want to measure a stock’s performance with respect to the overall market. Once the value of RSC is calculated for multiple time points, it can be plotted on a graph. The points where the line is moving horizontally denote that the security is performing as well as the overall index. If the line moves up, it means that the stock is performing better than the overall market, while downward movement indicates otherwise.
This is how simple it is, to use the RSC indicator.
So what can you do with it?
By now, you already know two uses of the RSC indicator. The first one is to compare the performance of two securities in a market over time. Similarly, it can be used to measure the performance of a security against the market index. While doing so, always check if the comparison makes sense. For example, it wouldn’t make sense to measure a company listed on the NSE against Japan’s stock exchange index.
On that note, take note of this important information - when you are using an index to compare a security’s performance against, it does not make the relative strength comparison indicator a relative strength index indicator - the two are very different from each other. Novice investors often confuse the two indicators.
Let’s look at another way of using the RSC indicator. Suppose that you are looking to invest in buying shares of a banking company. In the process, you get curious and start wondering as to how other banking companies have been performing, despite your pick’s good past performance. Interestingly, if you can find a banking industry specific index, you can measure your stock’s performance against its peers in the industry. This can help you determine if you are missing out on companies that are performing better in the same sector.
RSC can therefore be used in conjunction with fundamental analysis to filter out companies that are worse or better choices over others.
So, Vikas was actually using the RSC indicator that his digital broking partner provides in their full service brokerage option. He quickly looked up Rini’s picks against the market index, and they were performing worse than the index despite reporting positive growth.
And this leads us to the last subtlety to note when using RSC - the RSC values graph does not tell us if a security’s price is falling or rising. For example, the line could move upwards, even when the index price is falling faster than the price of the stock in our previous example.
Overall, RSC is a powerful stock selection tool, if all the other details are being paid attention to with solid research.
Friends, that is all we had for today’s podcast. If you liked this podcast, don’t forget to share it with your friends. Goodbye from Angel One, and as always, happy investing!