My question is concerning the relative strength of a stock. I have read that this is a good indicator for a stock, and that it should be 80 or above before you buy. Is this true? And what if the stock is below that, does that mean I shouldn't buy it? I would also like to know if there is a formula for coming up with that number. If so, is it possible for you to explain it to me. (February 25, 2002)
Relative strength is an important indicator, and typically we will want to see it strong (over 80 as published by Investor's Business Daily). That indicates that the stock has performed beftter than 80 percent of the other stocks it is being compared to - for IBD, that would be all the other stocks in its tables. On our charts we chart relative strength versus the S&P 500.
However, we need to keep it in context of all the information about a stock. We use it as a confirming indicator - that is, if the chart is good - a nice pattern with good price/volume action - we will always consider a play on the stock even if relative strength is not great. If relative strength is good, that further supports our analysis of the price/volume chart. One way we really like to look at relative strength is to see if it is actually 'breaking out' with the price. It is a strong signal if a stock's price is set to break out, and the relative strength line on the chart is also set to break over prior highs, or does so just ahead of the price. The RS line can also give us other signals. For example, if the price is moving laterally or moving up and down in a range, if the RS line is actually making lower highs that is a sign of growing weakness. If RS is getting higher, that is a sign of growing strength.
The computation is to compare the stock's price change over a given period (typically 12 months) to an index or other stocks. I have seen the actual mathematical computation, but it is best left to computers.
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