Online Foreign Currency Trading

Relative Strength - Not to be Confused With the RSI

Introduction
Relative Strength sits somewhere in the overlap between technical and fundamental analysis; the calculation involves price and can be plotted on a chart and the results can act as evidence of an instrument’s current fundamental position. It is not to be confused with the Relative Strength Index (RSI), which is a momentum based technical oscillator.
Definition
We can define relative strength as a measure of how one instrument compares to another, based on price. It is calculated by dividing the price of one instrument with that of another over the same period of time. This ratio can then be plotted on a simple line graph to aid visual comparison.
This form of analysis is extremely popular amongst stock traders and investors who can use the ratio to identify the highest performing sector in any market, the highest performing stock in any sector or even the nation with the highest performing equity market on the global stage. One form of common analysis is to compare a single stock to a market wide benchmark such as the S&P500. Markets and sectors with the highest relative strength are, in theory, most likely to contain and yield the stocks with the greatest near term investment potential. Of course relative strength is just one tool in a toolbox and cannot be used to complete an entire analysis project.
Use in the Forex and Commodity Markets
The use of Relative Strength is not as widespread in the forex and commodity markets due to the fact that there are far fewer instruments to trade and there is no benchmark index (the exception to this rule is the Dollar Index). Therefore the method used to apply relative strength analysis has to be slightly modified. For forex, it may be useful to check the relative strength of a number of currencies against one single currency. For example you could compare the Euro, Pound, Yen, Swiss Franc, Australian Dollar etc against the US Dollar to find the strongest performing currency, or compare the EURUSD, GBPUSD etc to the Dollar Index. This may be useful if you believe the US economy to be weak and you wish to verify your fundamental research of other world economies and highest potential returns when selling dollars. If you were to compare the EURCHF, GBPUSD and the CHFJPY you could identify the ‘strongest performing pair/ cross’ but not the strongest currency because you are involving multiple currency variable and comparisons are therefore completely out of context.
In terms of the commodity market there are more clearly defined sectors in which to identify the best performers. These are: precious and base metals, agricultural, oil and energy. You can apply relative strength analysis to each commodity within these categories to find the strongest performer. Once again though you will have to compare each commodity to the others in that category rather than a benchmark index.
Cross Market Analysis is Possible
Although we have mentioned that it is fairly pointless conducting relative strength analysis on the GBPUSD vs the CHFJPY to identify the strongest currency, cross-market comparisons are possible and can be said to hold analytical value. As a crude form of comparison stocks and bonds are often compared in this fashion to answer the question: “Would you have made more from investing in Stocks or Bonds over the last five years?”