The RS concept

After this lesson you'll know what relative strength actually measures, and why this whole Academy is organized around it.

Strong compared to what?

Everything before this school measured stocks against themselves: their own trend, their own volume. Relative strength (RS) adds the comparison that was missing. How is this stock performing against everything else, starting with the index it lives in?

The definition is simple. Take a window, say three months or a year, and compare the stock's return to the benchmark's over that stretch. If the market is up 10% and the stock is up 45%, that's strong. If the market is up 10% and the stock has managed 3%, the stock is weak, whatever its own chart looks like in isolation. Strength is a ranking of one thing against another, so the word on its own doesn't say much until the comparison is named.

The part beginners resist

The instinct nearly everywhere else in life is to buy the thing that's marked down, and to leave alone the thing that has already gone up, because you missed it. Relative-strength trading works the other way round. It buys stocks that are already measurably stronger than the market, and it leaves the laggards where they are, however cheap they look.

Two things hold that up. One of them you already have.

The one you have is School I, course 3. The giant funds take weeks and months to build positions, and their buying is what sustained outperformance looks like from outside. A stock beating the market month after month is usually a stock someone enormous is still accumulating, and RS is the footprint-reading you were promised. The stock that's down 60% while the market rallies is being read the same way, from the other side.

The second is the evidence. The tendency of recent winners to keep outperforming, the momentum effect, is among the most persistently documented phenomena in all of finance. It has been studied across markets, countries and decades since Jegadeesh and Titman's landmark 1993 paper, and practitioners observed it for a good deal longer than that. The academic literature and the trading lineage this Academy teaches (course 7 introduces them properly) came at the question from different directions and landed in the same place. Hold it honestly, though: a persistent statistical tendency, with losing stretches inside it, and no promise about any particular stock. School VIII teaches you to keep claims like this one on that leash.

Three comparisons

RS gets computed against three benchmarks, and each one asks a different question. Against the index, whether the stock is beating the market at all, which is the basic admission test. Against its sector, whether it's strong on its own merits or just riding a hot group; course 4 takes that apart. Against its direct peers, whether it's the leader of the group or a follower, which is course 3's subject. A genuine leader ranks high on all three.

Check yourself

1. A stock is up 20% this year. Strong? (Unanswerable as asked — compared to what? If the index is up 30%, the stock is a laggard, green number and all.)
2. What does sustained outperformance suggest, mechanically? (Ongoing accumulation by participants too large to finish quickly — School I's constraint, read from outside.)
3. Why does buying strength feel wrong to beginners? (Because everywhere else in life, buying what's marked down is the sensible move. Markets are the exception: what pays here is the merchandise the biggest buyers are still accumulating.)

The idea this lesson installs

Strong means stronger than something; always name the something.

Next: Course 2 — "The RS line."