Relative strength is a calculation investors use to find the best-performing stocks, mutual funds and exchange traded funds by comparing them with each other. This measurement is often a tool for investors using a momentum strategy of finding the highest-performing investments under the assumption that they will keep performing at that level. Finding relative strength can be done using a simple calculation with freely available financial information.
Relative Strength Basics
Investors use relative strength to find the top price performers among a group of investments. The relative strength of a stock can be compared with an index such as the S&P; 500 to gauge the stock’s performance against the whole market. However, mutual funds are measured against each other. A mutual fund prices its share by calculating the net asset value, or NAV, which is the total value of the portfolio divided by the number of shares issued. Relative strength is only useful when comparing it against other mutual fund NAVs, such as in narrowing down potential purchases or evaluating the mutual funds in a portfolio.
Relative strength is a measurement used for a strategy called momentum investing, described by "Forbes" magazine as “buy high, sell higher.” Momentum investing seeks to find investments that are rising the fastest, usually looking at the prior six- or 12-month period, according to "Business Insider." The strategy is based on the philosophy that the highest-performing investments will continue to rise at a higher rate than the market.
Relative Strength Formula
The most basic formula to calculate relative strength measures the investment’s current price to its price at a recent past date, often three months or one year. To find the fund’s relative strength, decide what time period over which to evaluate the fund, and find both the current NAV and the NAV at the period's beginning. Subtract the past NAV price from the fund’s current price, then divide that total by the past NAV. For example, the three-month relative strength of a fund that has a current NAV of $11 and a three-month NAV of $10 is 10 percent. Funds with a lower percentage have less relative strength and are less attractive to hold.
Relative Strength Index
Investors should not confuse relative strength with the relative strength index, or RSI. While relative strength is used to compare one investment against one or more other investments, the RSI only evaluates a single investment, which can include stocks, mutual funds or ETFs. According to Scottrade, the RSI measures a series of price and performance fundamentals for the investment and plots the result on a graph. Analyzing an investment’s RSI can help determine if it is overbought, where the fundamentals don’t match the buying trend, or oversold, where it sells below a fair price.
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