Relative Strength: A Guide to Momentum Investing

What is relative strength?

Relative strength is a momentum-based investment approach that seeks securities (stocks, sectors, ETFs, bonds, REITs, etc.) that are outperforming a chosen benchmark or their peers. The idea is to follow assets showing stronger upward momentum with the expectation that the trend will continue long enough to produce additional gains — essentially “buy high, sell higher.”

Key takeaways

• Relative strength focuses on outperformers versus a benchmark (e.g., S&P 500, Nasdaq).
• It assumes existing trends will persist; sudden reversals can produce losses.
• Works across asset classes: equities, ETFs, bonds, REITs, commodities, and derivatives.
• Technical traders often pair relative strength with indicators like the Relative Strength Index (RSI) to time entries and exits.

How relative strength works

• Select a benchmark or peer group.
• Compare individual securities or sectors to that benchmark (price performance, returns).
• Favor those that have risen faster than peers or declined less during downturns.
• Reallocate periodically toward current outperformers and away from laggards to capture continuing momentum.

When it works—and when it doesn’t

• Most effective in stable, trending markets where momentum persists.
• Risky during high-volatility or crisis periods when market sentiment can flip quickly, causing sharp reversals.
• Momentum strategies can underperform in mean-reverting environments or when leadership rotates rapidly across sectors.

Practical applications

• Individual stocks: pick companies consistently outperforming their sector or the market.
• ETFs/index funds: rotate among broad market or sector ETFs based on relative performance.
• Fixed income vs. equities: shift allocation between bond and equity funds when one asset class outperforms the other.
• Other assets: apply the same comparative approach to REITs, commodities, or derivatives for diversification or tactical positioning.
• Can be combined with other strategies (e.g., pairs trading, factor overlays) as part of a broader portfolio plan.

Example

Harry monitors the S&P 500 and a corporate bond ETF. Observing bonds outperforming stocks, he reduces his S&P 500 allocation and increases his bond ETF exposure to capture continuing relative outperformance. If the trend reverses, he must be ready to reallocate to limit losses.

Relative Strength Index (RSI)

• The RSI is a momentum oscillator that measures recent price changes on a 0–100 scale.
• Common interpretation:
• RSI ≥ 70 — potentially overbought (possible pullback or reversal).
• RSI ≤ 30 — potentially oversold (possible buying opportunity).
• RSI is a timing tool often used with relative strength selection but should not be the sole decision trigger.

Practical tips for investors

• Use relative strength as a systematic part of a written plan with clear rebalancing rules.
• Pair momentum rankings with risk controls: position sizing, stop-losses, or diversification.
• Reassess holdings regularly—momentum leadership can change quickly.
• Combine quantitative screening (performance rankings) with qualitative checks (fundamentals, liquidity).
• Be cautious in extreme market conditions and consider blending with defensive strategies.

Bottom line

Relative strength is a momentum strategy that targets assets currently outperforming a benchmark in the expectation those trends will continue. It can be applied across many asset classes and enhanced with tools like the RSI, but it carries notable risk during abrupt market reversals. Discipline, risk management, and timely monitoring are essential when implementing relative strength strategies.