Although there are ultra-sophisticated ways to use relative strength as an investing strategy, there's also a simply, but very effective approach.
This article is published with permission from InvestmentU.com.
Last week I wrote an article stating that the best time to buy on a dip is when the Relative Strength Indicator (RSI) generates a buy signal. So far, the S&P 500 still needs to decline a bit more before an RSI buy signal is even possible.
I wouldn’t be a buyer of anything until the S&P 500 does generate that buy signal. But the big question is: When the general stock market does see the “buy signal” you’ve been waiting for, what stocks should you buy?
The answer ties back into the technical approach that I use to find the best stocks and sectors to invest in. That approach is called “Relative Strength Investing.”
There are ultra-sophisticated ways to use relative strength, but today I’ll go over a “quick and dirty” method that my second-grader can follow. But don’t let the simplicity fool you. It’s still a very effective approach.
You simply note which stocks are not getting clobbered in the current market correction. When a stock or sector outperforms the general market, that means the stock or sector is showing positive relative strength. This reveals the areas of the market that aren’t only “rising with the tide,” but have strength of their own, without the help of broader market trends.
Let’s look at Netflix (Nasdaq: NFLX), for example. It was the best-performing stock in the S&P 500 last year, up a whopping 298%.
It’s tough for investors to buy a stock that has already jumped 50%, 100%, 200% or more, which is why it’s tough for the average investor to stomach using relative strength strategies to invest. It means you’re buying stocks that have already gone up a lot.
On Jan. 23, when the S&P 500 declined 0.87% (orange line), Netflix jumped 16.51% (blue line). Over the next couple of trading days, Netflix declined only 1.5% while the S&P 500 declined 2.6%.
From that point, the stock gained another 6.3% while the S&P 500 lost another 1.8%. Throughout this process, Netflix is breaking all-time highs!
The point is, this is a classic example of the kind of stock that will make my shopping list the next time I’m a buyer.
Index fund traders dominate the stock market. That means fund managers, who don’t care about individual stocks, do the vast majority of the trading activity that occurs each day. If they need to “sell the S&P 500,” they are putting in sell orders to sell every stock in the index, including Netflix.
Despite the selling pressure from all the index fund traders out there, Netflix’s stock still has enough demand to send it up 22% (while the S&P declined by 5%).
Considering that stocks breaking all-time highs continue to charge higher, and considering the fact that this stock is able to charge higher even as it swims against the market current, what do you think it will do when the bulls return to the general market?
This article is not meant to be a Netflix buy recommendation. But this illustrates the types of stocks you should be watching today and consider buying when the bulls return to the market.
Chris Rowe is a member of the Investment U Research team.
The information contained in this article should not be construed as investment advice or as a solicitation to buy or sell any stock. Nothing published by Physician’s Money Digest should be considered personalized investment advice. Physician’s Money Digest, its writers and editors, and Intellisphere LLC and its employees are not responsible for errors and/or omissions.