The Indian equity markets feature thousands of listed stocks, but not all of them are suitable or advisable for trading. As traders, our focus is on stocks that outperform others or excel within a specific group. This can be achieved using the tool of Relative Strength, which helps identify and eliminate underperforming stocks from consideration.

Relative Strength is a broad and impactful concept. In this series, we will explore its fundamentals, delve into patterns of Relative Strength, understand Ratio charts and their analysis, and examine various tools and scanners that traders can use to apply Relative Strength effectively.

In today’s newsletter we understand the basic idea of Relative strength and why a trader should use Relative strength to build an edge in their trading system. We will also look at the concept of Outperformance and Underperformance.

Relative Strength: The name says it all

Relative Strength is a tool widely used by successful traders. “Relative” refers to comparing a particular entity to another. In the context of trading, it refers to comparing an asset, stock, or index to another. "Strength" refers to the performance of an asset, stock, or index, measured by its percentage change in price. Therefore, we are comparing an asset, stock, or index’s performance to that of another asset, stock, or index. In this newsletter, we will discuss comparing stock to index. Although, this concept can be used to compare any asset, stock, or index.

This is the core concept of Relative Strength: to compare the performance of a stock to that of an index. Its significance lies in helping traders filter out stocks that are underperforming relative to the market, as represented by the index. If a stock's performance does not align with or surpass the overall market, it may not be worth trading.

When a trader has a bullish outlook, they can focus on the stocks that are performing better than the index such as Nifty 50, Sensex, Nifty 500, or any respective sectoral index such as Nifty Bank, Nifty FMCG etc. This way, they are choosing the stocks that can give a better return than the average market index returns.

Concept of Outperformance and Underperformance

The terms "Outperformance" and "Underperformance" are commonly used in the context of Relative Strength. To understand these terms, it is essential to grasp the concept of the numerator and denominator in Relative Strength. Since Relative Strength involves comparing one entity to another, we use numerators and denominators, as in fractions, where the numerator represents the entity being compared to the denominator. In Relative strength, the numerator can be an asset, stock, or index and the denominator can be another asset, stock, or index.

Outperformance refers to the numerator performing better than the denominator.
Underperformance refers to the denominator performing worse than the denominator.

It is important to understand outperformance and underperformance from the perspective of numerator and denominator. This enables us to decode Relative strength in terms of patterns.

This newsletter was an introduction to the basic idea of Relative strength. In the following newsletters in this series, we will delve into the patterns and tools of Relative strength that a trader can use to build an edge in their trading strategies.

Relative Strength alone does not guarantee trading success. To make informed decisions, traders must combine Relative Strength with price charts, patterns, and other indicators. These essential tools and techniques are covered extensively in the TNT One exclusive membership, which provides access to a comprehensive library of resources on various charting methods and tools. If this newsletter has piqued your interest in trading, be sure to explore the link below for more details.

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