Absolute Strengh Market v1.1

  • Post category:MT4
  • Post comments:0 Comments
Absolute Strengh Market v1.1

Market strength is a broad term that can mean a lot of things, depending on how we define it. Market strength can be a measure of a market’s power to perform either on a relative basis (vs. other markets) or on an absolute basis (vs. its own historical levels of momentum and investor participation).
First, we’ll take a look at the
relative strength of a market. Relative strength is a technical analysis metric that’s not relegated to intermarket analysis (that is to say, it can be used for individual stocks just as effectively), but it’s arguably at its most powerful when used to help select the strongest asset class.
Essentially, relative strength is just the ratio of one asset to another over a period of time. By taking the daily close of the S&P 500 divided by the daily spot price of gold, for example, you’ll get the relative strength of the S&P (or more broadly, of stocks) vs. gold. Because relative strength is a ratio of two disparate items, it’s not the value of an asset’s relative strength but rather its change over time that bears monitoring.
By looking at relative strength of various asset classes over the long-term, technical traders can determine when it makes sense to rotate a portfolio from a relatively weaker asset to relatively stronger assets. Of course, it’s crucial to monitor the assets themselves at the same time — using relative strength alone, it’s possible to invest in the “least worst” of two declining assets.
The abundance of new, commodity, currency, and foreign equity exchange traded funds has made this method of trend trading especially popular in recent years.
Using Absolute Strength to Spot Market Reversals
The other way to look at market strength is to compare a stock’s current metrics against historical ones. By doing this, traders can get a sense of where in its investment cycle a market may be — and also discern how much strength a trend has and when a reversal may be likely to occur.
It’s the latter half of absolute strength measures that makes them particularly actionable.
In this context, measuring market strength is called market breadth. It focuses on how individual issues in the market are contributing to its overall performance. The reasoning is simple: If an index such as the S&P 500 is increasing but those increases are coming from few stocks, the setup suggests that the uptrend is losing strength and is more likely to reverse.
As you might expect, many indicators exist to help identify market breadth — far too many to detail for the purposes of this primer. That said, it does make sense to take a look at the most popular: the Advance/Decline Line, or A/D Line.
The A/D line is essentially a running tally of the market’s advancing stocks minus the market’s declining stocks. As with relative strength, it’s not the value of the A/D Line that matters (it’s an arbitrary number), but the change in the A/D line. An upward sloping A/D line coupled with an upward sloping market means that the market’s increases are due to an abundance of advancing stocks in the market.
When the A/D Line’s trend becomes out of synch with the broad market, it suggests that the market is losing breadth and may be due for a reversal.
Scores of popular market breadth indicators are available in most charting software packages. Select one that makes sense to you, and you can start applying breadth measures to the broad market to spot signs of weakness. Remember that indicators like market breadth are confirmatory — wait for a technical signal based on price action before trading them.
Check out our other technical primers, including “Making Sense of Moving Averages” and “Understanding Market Momentum.”


Download Now

Leave a Reply