Relative Strength Is All Relative
Relative strength is something that all investors should understand.
It doesn’t matter if you’re involved in stocks, real estate, or just saving money… relative strength applies to everything.
There is an actual financial tool called the Relative Strength Index – RSI. This is one of those financial terms that is made way more confusing than it needs to be.
Here is the definition from Investopedia:
“The relative strength index (RSI) is a momentum indicator developed by noted technical analyst Welles Wilder, that compares the magnitude of recent gains and losses over a specified time period to measure speed and change of price movements of a security. It is primarily used to attempt to identify overbought or oversold conditions in the trading of an asset.”
But an easier way to think of this index is simply by thinking about price movements. If prices go up very quickly, they’re probably due to fall quickly. If prices fall quickly, they’re probably going to bounce back quickly.
This is something we have seen many times recently.
Think of the housing market right before 2008. Because of loans that were too easy to qualify for, housing prices shot up faster than any other time in US history.
Then, houses crashed. Simple. Huge gain, huge loss.
Now think of the housing market over the past 100 years. It has been a steady increase, relative to the time period. There is relative upward strength over that long period of time
The relative strength in the quick price bump right before 2008 was weak. Because the huge bump was over a short period of time, which means it was overbought over the larger timeframe. So, in relative terms, that price move was weak.
Let’s look at the historical chart of the S&P 500 ETF ($SPY). This stock basically tracks the S&P 500. Now, look at the yellow line at the bottom of the chart. When the line moves too high or too low, it is signaling a move that is out of the ordinary relative to its normal strength.When the line is very high, it’s overbought – just like in 2000 and 2008. That’s because everyone was buying stocks at high prices.
When the line is very low, it’s oversold – just like in 2003 and 2009. That’s because everyone was selling stocks and too afraid to buy.
As an investor, we should look for times to buy when the market is oversold. We try to avoid buying at times when the market is overbought.
This is exactly like buying clothes. Would you rather buy a shirt when it’s full priced or when it’s on sale?
We want things cheap! I don’t like to waste money on anything, and I know you don’t either.
Now, looking at the RSI for stocks is easy. There are all kinds of resources online that do all the work for us. We just have to look at a chart that is neatly presented to us.
But what about real estate or other types of investments?
This is where things get a little more tricky. There is lots of data to follow real estate, but nothing as in depth as a stock screener.
Plus, real estate markets are extremely dependent on region. Some places in the US are still very cheap right now, while others are completely out-of-control expensive.
Likewise, there are some parts of the world that are selling for dirt cheap, while there are others that are sky-high.
So, how can you tell if a market is cheap or expensive?
That’s where our work comes in. We have to look at the relative strength. We have to research historical prices, look at trends, and find out the emotion of the local market.
This hard work that must be done is what sets apart successful investors from the ordinary (or unsuccessful) ones. When you figure out this information, you are setting yourself ahead of the crowd because this type of information is not readily available like all those online resources for stocks.
Now, I’m not saying that there isn’t money to be made in the stock market, I’m just saying that there are other markets where we can give ourselves huge advantages.
In the stock market, things move fast. We can make money on trades that we research, but we’ll have lots of competition.
In real estate (and other investments), money isn’t made as fast. However, what these ‘slow’ investments lack in speed, they make up for in security. We can ensure better investments by providing ourselves with better information that has less competition.
The Relative Strength Index is a great tool for the stock market. But, we can also look at the relative strength of other markets to give ourselves an even better leg-up on the competition.
So, the next time you invest in anything, figure out the relative strength of the investment.