Yet another trader question! They are coming fast these days, which is fantastic.
I enjoyed reading your excellent book. Just one clearifying question. Could you tell me exactly how to calculate Relative Strength?
This is a bit of a tricky answer, because Relative Strength has multiple meanings in trading parlance. Let me see if I can provide quick definitions of each.
The first variation of Relative Strength is a comparisson of one stock or other market to another. This is a relative performance measure which can be calculated in a couple of ways. One is to just do a simple ratio of one over the other. If, for example, we’re comparing GOOG and YHOO it would mean dividing the price of GOOG by the price of YHOO (or the other way around), then plotting the result. The line that creates will rise and fall based on which stock is performing better.
Alternately, you could do some kind of look-back calculation to determine % gain over a specified time period.
I believe that RS, as determined by the folks at Investors Business Daily, is based on that later type of determination, but don’t hold me to that. I’m not sure.
The Relative Strength Index (RSI) is something all together different. Essentially, RSI measures internal strength – the relative performance of something against itself as opposed to against something else. The folks at StockCharts.com have a good presentation of the calculation of RSI and its application here.