Bottom Up—Specific Stock Selection and Relative Strength

At present, almost 8,000 stocks trade in the active stock markets in the United States. This number is too large for an analyst to screen at frequent intervals. Some technical analysts briefly inspect the chart of every stock in their universe, using either a bar, candlestick, or point-and-figure chart. This is a laborious process and far from objective. Others screen through relative strength ratio charts. The least time-consuming and most objective method is to screen all stocks on a periodic basis for relative price strength using one of the methods described next. Relative strength provides evidence that a particular stock is outperforming the market and is very likely in a strong, upward trend. These methods have also been used successfully in mutual funds, ETFs, industry group selection, commodities, and foreign securities.

Relative Strength

Most technical screening methods use a concept called relative strength to judge which securities have the most promise. Relative strength is a reliable concept that has been demonstrated academically and practically to have value. Indeed, because the method is so successful, it is the primary argument against the Random Walk and Efficient Markets Hypotheses. The presumption behind the concept of relative strength is that strength will continue, similar to how trends will continue, and that by recognizing the strongest trends, an edge can be obtained by investing in them until their strength abates. If the strongest stocks remain strong, the market cannot be random or efficient.