RELATIVE STRENGTH RANKING

RELATIVE STRENGTH RANK IS NOT RSI, (or Relative Strength Index),

where the stock is compared against itself, other similar industries or sectors or
indexes...

This is a measure of price performance of the stock during the previous 12
months AGAINST THE ENTIRE MARKET IRRESPECTIVE OF EXCHANGE.
If we have a stock that has been ranked as 80 or better, that means that this stock
viewed from the perspective of price outperformed 80% of ALL other common
stocks in the entire database during the last year, (previous 52 weeks).
You can use the Stock Screener on over 10,000 stocks for relative strength at
StockTables.com
The Pitbull Investor Stock Trading System utilizes Relative Strength RS
Rank as one of the main criteria for a stock buy signal.
This is an extremely powerful stock screen technique whose importance lies in its
ability to, many times, anticipate moves BEFORE they happen.....

As an example, many times a rapidly appreciating stock will continue to improve
in a positive market, but its Relative Strength Rank will begin dropping, which
means that there is a hidden loss of momentum masked by the favorable price
increase. In reality the stock is not keeping up with the rest of the market; not
even coasting on the free ride given by rising indexes like the DOW,S&P or
NASDAQ. This occurs many times just before the stock "rolls over" and begins
to head south, so many times you can exit a position while it is peaking instead of
waiting to accept an 8 or 10% loss off of peak price.

Conversely, in a poor declining market, a stock that steadily improves in RS
RANK, even though its price may not be changing can indicate a true underlying
strength, beating all other stocks, and a broad market rally will see these stocks
take off faster and with greater momentum than market laggards.
When you select RS Strength Rank from the Criteria menu you can then click on
"ALL" which means that you will accept all rankings, or any of the graduated
selections below. As an example, clicking on "80+" means that you will only
accept screens of stocks which have 80 or greater relative strength. Conversely, if
you were to choose "<30" you would be looking for stocks which were
performing worse than 70% of the market.

You will find that our Relative Strength Rank does not exactly match those of
financial newspapers, TeleScan or Telechart who also provide their own
proprietary rankings. Indeed you will see vast differences between most of these
services because of the way and the frequency with which they do their updates.
Some sources only update once a week, or even once a month, while others
update nightly as we do.

The source that we have used for our Pitbull Investor Selections for the past 12
years has been a manual screen of the daily financial newspaper. Now we use
Stocktables every day along with the Stock Market Crash Index
SO HOW DO WE COMPUTE OUR RELATIVE STRENGTH
RANKINGS?

TeleScan and Telechart all have their own closely held methods for
computation of rankings. We have spent more than a year and a half developing
our own proprietary algorithms which we believe to be superior.

We started with a multi -year study conducted by members of the Toronto Stock
Exchange, (Foerster, Prihar & Schmitz in their article "FPS Quarterly
Weightings"), in developing their own method for computing RS Rank for the
TSE. We chose this starting point because it was a published paper which
revealed 4 different methods they were exploring with over 30 years worth of
data.

Based upon that study we continued our own research to more even-handedly
evaluate the dramatic inequities induced in the market by stocks that were less
than one year old or that had had dramatic near term volatility.

The results we believe, speak for themselves, in the form of a truer picture of a
stock's position in the marketplace. Like most others, we give more weight to
current price performance and less weight as we look at data that is aging, but that
is where the similarity stops. As an example, we do not consider a stock that has
gone from $10 to $100 and back to $80 to be the same as a stock that has gone
from $10 to $80 and held its position. The stock that has had a 20% recent loss is
ranked very low because of its current performance. In other Ranking systems it
would take many weeks for this effect to come to parity where we can do it in just
a day or two showing market turns much more rapidly before you lose 10 or 20%
on your investment.
Relative Strength Rating Pinpoints A Stock's Power
Everything in the stock market is relative. You want to buy stocks that are,
relatively speaking, better than others.
You want strong gains relative to the market. You'd like to be able to achieve all
of this with relative ease.
Two helpful tools on all three counts are IBD's Relative Price Strength Rating and
the Relative Strength line.
The RS Rating gauges a stock's performance vs. all other stocks in IBD's database
over the past 12 months. Stocks like Mellanox Technologies (MLNX), with a 99
rating, have outperformed 99% of all stocks tracked by IBD over the past 12
months.
IBD Chairman and founder William O'Neil says RS Ratings are similar to
fastballs thrown by the best pitchers.
"The average big league fastball is clocked at 86 miles per hour," O'Neil wrote in
"How to Make Money in Stocks." "The best pitchers throw 'heat' in the 90s.
An RS rating of 90 or better means a stock is already outperforming 90% or more
of the market even before possibly breaking out and starting its run.
But like any other measure, a high RS Rating doesn't guarantee a winning run; it
alone is not a buy signal, but simply one element helping you increase the odds of
making money.
A stock that has sprinted straight up for weeks or months is likely to hold a high
RS rank. But it will often be extended, with no real buy point in sight. The trick is
to find a stock that has managed to build or maintain a high RS Rating while
basing.
The Relative Strength line gauges a stock's performance vs. the S&P 500 index.
A rising line means the stock is outperforming the broader market. That's good.
What you ultimately want to see is a stock near a buy point, showing a high RS
Rating (say, 90 or better) with an RS line that in most cases is near or breaking to
new highs. IBD research shows, from 1950 through 2008, the average RS Rating
of the best-performing stocks just prior to their winning runs was 87.
You can find RS Ratings in numerous places in IBD and at Investors.com. In an
IBD chart, the RS line is painted blue and usually found under the price bars.
Take a look at the charts for Mellanox. It had the combination of a top-shelf RS
Rating and an RS line moving to new highs just before it broke out June 11.
Or compare Apple (AAPL) and Priceline.com (PCLN) both climbing the right
side of three-month bases. Apple's RS Rating is a 93, down from 96 five weeks
ago. Its RS line has inched up and is leaning toward a new high.
Priceline's RS Rating has held steady near 88 for the past five weeks. Its RS line
has ebbed, however, and is well below its April high. Keep an eye on the RS line
as leading stocks climb the right side of their respective bases.
Momentum Trading [Part 1 of 3]
By Dr. Bruce Vanstone
Introduction
The purpose of this 3-part series of articles is to provide information about the
potential benefits of momentum investing. In this series, I will try and explain
what momentum is, the potential returns available to momentum investors, and
the way that Porter Capital combine mechanical, rules-based strategies with the
momentum effect to deliver benefits to investors.
The 'premier' anomaly
Since its initial discovery by DeBondt & Thaler in 1985
[1]
, the momentum effect
has been documented and researched in many markets worldwide.
Many traders and investors would know of the academic notion of the efficient
market, and the implication that this efficiency has on the ability of investors and
traders to earn profits.
What you may not be aware of is that the father of the efficient market
hypothesis, Eugene Fama, refers to momentum as the premier unexplained
anomaly
[2]
. In other words, the success of momentum based investing is
regarded by many as an exception to the efficient market hypothesis.
What is it?
In its simplest terms, momentum refers to buying stocks which exhibit past over-
performance. Research shows that stocks which have exhibited strong
performance over some defined historical period, have a tendency to continue to
exhibit strong performance for some number of future periods. It means that
investors can potentially hitch a ride on strong momentum stocks. In part 2 of this
series, I will use simulations to explore the potential risks and rewards of the
momentum approach.
A Typical Momentum Trade
The typical momentum trade has a history of clearly defined direction and
strength. Figure 1 shows a chart of price activity for ALL (Aristocrat Leisure),
from August 2004 to April 2005. During late August 2004, there is a clear price
breakout on very heavy volume. This marks the start of the momentum
opportunity. Over the next few months, the price activity demonstrates clearly
defined direction.

Is it credible?
The momentum effect has been widely researched and documented in both the
international and Australian equity markets. For example, Rouwenhorst
[3]
tested
momentum strategies in 12 European markets using data from 1980 to 1995, and
found that momentum returns were present in every country, and their effects
lasted for approximately one year. Griffin et al.
[4]
found support for the
profitability of momentum investing in over 40 countries, and concluded
Globally, momentum profits are large and statistically reliable in periods of both
negative and positive economic growth.
Momentum has been thoroughly researched in virtually all of the worlds equity
markets. Momentum effects have also been documented in other asset classes,
such as foreign currencies
[5]
, commodities
[6]
and real estate
[7]
.
It is fair to say that the momentum effect appears to be one of the most beneficial
effects for investors. Thorough research appears to indicate that momentum based
investment does not increase investment risk, and that momentum effects are
present during both economically good and bad cycles.
When does it work best?
Like all investment approaches, momentum investing is subject to the vagaries of
the investor. For many investors, poor returns are not so much a function of their
investment strategy, but of their own implementation of that strategy.
All investment strategies benefit from the increased discipline and accountability
that mechanical, rule-based trading brings, particularly during difficult investment
cycles. I will discuss this topic in more detail in the third part of this momentum
series.
Introduction
This article is part 2 of a 3-part series. In this article, I will focus on using
simulations to demonstrate the potential risks and rewards of the momentum
approach. In the final part of the series, I will discuss the way in which investors
can benefit from rule-based approaches to investment.
Creating Momentum Simulations
The results presented in this article are a quick demonstration of the potential of
the momentum effect for Australian investors. I like to use simulations as they
provide an excellent opportunity to see how well a strategy could have performed
in the past. Simulations are also useful because they can give some clues as to
how a strategy may perform in the future. However, we must always remember
that past performance is no guarantee of future performance.
The simulation results in Table 1 have been created by calculating momentum on
a historical rolling monthly basis for each member of the ASX200, and holding
the top group of stocks each month. The data used contains delisted stocks, and is
adjusted for survivorship bias as and where possible. Both simulations assume the
same starting capital and account for transaction costs and slippage. The
simulations cover the 10 year period from 2000 to 2009.

Applying Simulations to the ASX200
Table 1: Simulations of the Momentum Effect for Australian Investors
The columns contained in the table are explained below:

Figure 1 shows an equity graph plotting a simulated portfolio versus the ASX200
(XJO) index portfolio.

Historical
Momentum Period
Risk
(Max
DD%)
Reward
(APR%)
ASX200
benchmark
Risk (Max
DD%)
ASX200
benchmark
Reward
(APR%)
12 -60.07% 18.54% -53.13% 4.76%
Historical Momentum Period The number of months over which historical
momentum was measured
Risk (Max DD%) Risk as measured by the maximum drawdown
Reward (APR%) Reward as measured by APR (annual percentage
rate)
ASX200 benchmark Risk
(Max DD%)
Risk as measured by the maximum drawdown in
the equivalent benchmark (XJO)
ASX200 benchmark Reward
(APR%)
Reward as measured by APR in the equivalent
benchmark (XJO)
Conclusions we can draw from this
In the first article of this series, I pointed out that the momentum effect appears to
be one of the most beneficial effects available to investors. The results in Table 1
and Figure 1 clearly confirm this observation.
The results above also confirm that to capture the benefits of a momentum
approach, investors do not need to trade frequently, or with huge sums of capital,
or in high-frequency timeframes. Instead, what is required is a disciplined, rules-
based approach to investment, and a strong focus on risk management.
Although the momentum approach has slightly higher maximum drawdowns than
the ASX200, the "potential" returns are substantially higher. Clearly though,
investing using momentum alone is not a holy grail for investors! However, these
results confirm that the momentum effect could be used to form the basis of an
actively managed investment strategy, one that focused on trying to capture some
of the outperformance, while still keeping an eye on risk.
In the third part of this series, I will discuss the benefits to investors of
mechanical, rules-based trading approaches. Many investors receive sub-standard
investment returns, particularly when managing their own capital. In some cases,
it is not the strategy itself, but the way it is being implemented which is at fault. If
you find yourself attempting to second-guess the way you trade, or you are unsure
how to react during periods of market turmoil, then it is likely that you could
benefit from the increased discipline and accountability that mechanical
approaches can deliver.
Introduction
This article is part 3 of a 3-part series. In this final article, I will summarize the
key characteristics of investing using momentum based approaches. I will also
discuss some approaches to managing risk in momentum models, and the benefits
investors can expect when investing with rules-based funds.
Key Characteristics of Momentum Approaches
Perhaps one of the main benefits of the momentum approach is that it actually
makes sense! It is not overly complicated to understand, it doesn't rely on split
second timing, and it doesn't need huge sums of money to implement.
From a quantitative point of view, momentum trading also carries a number of
clear benefits. It is simple to quantify, it is non-subjective, and it is robust to
parametric modelling changes. The momentum approach also has academic
credibility, and is the subject of ongoing research by some of the worlds best
finance academics. The simulations in Part 2 showed that although there is
slightly more "raw" risk than pure index investment, there is the potential for
substantially higher returns.
It is precisely this possible mismatch between risk and reward which qualifies
momentum as an approach worth further study. It's no wonder academics call
momentum, "the premier anomaly"!
Managing Risk
Fortunately, there are a number of ways to manage risk that fit with the
momentum approach. Distinguished academics like Andrew Lo have published
useful research on the potential benefits of stop loss structures on momentum
investment, demonstrating, at least in theory, that stop-losses can be of benefit to
momentum based systems [1]. Other academic studies have investigated
approaches like long-short investing, and hedging, which are techniques that have
traditionally been used to reduce trading risk.
Another way of managing risk is to focus on investing when momentum models
work the best. The time that momentum models outperform is when there is a
clearly defined direction for the overall stockmarket. When the market direction
tends to be sideways, it may be better to convert a momentum portfolio back to
cash. In the shorter term, this may increase the number of months when small
losses occur. However, in the longer term, it will help preserve capital during
periods when there is no real expectation from the momentum approach. This
ensures that when the market clearly establishes its overall direction, the investor
is ready and able to take advantage of it. This is the approach employed by Porter
Capital Management. I have included 2 graphs of quarterly returns for the
simulation performed in article 2 of this series. The first graph shows the effect of
keeping a momentum portfolio fully invested. The second shows the benefits
derived by converting the portfolio back to cash when the market shows no clear
direction. It is clear in the second graph that several of the quarterly returns have
been shifted in a positive direction.

Figure 1: Portfolio fully invested

Figure 2: Portfolio converted to cash when market 'directionless'
Perhaps the most important consideration when using a momentum based
approach is the idea of using models and rules to frame the way risk and returns
are managed. Research tells us that to be successful in trading and investing
requires a well defined plan, which encompasses not only entry and exit
decisions, but also covers risk and money management. Having such a plan helps
investors cope with the inevitable volatility that markets bring, especially during
times when financial markets are under stress.
Importance of rules-based investment
For the average investor, trading and investing are difficult propositions. The
average investor needs to invest a significant amount of time to develop the level
of market expertise required to be successful.
As I have suggested in Part 2, many investors receive substandard investment
returns, and in many cases, it may well be that the investors own behaviour is to
blame. Research tends to show that investors have a number of well documented
behavioural problems! For example, it has been shown that investors tend to
overtrade their accounts to their detriment [2], and, that although investors may
pick good stocks they tend to sell winners too early and sell losers too late [3].
Rules based investment allows the investor to specify the conditions under which
he will buy or sell stock, and how much stock will be bought or sold. Using rules
to quantify your trading decisions leads to clear entry and exit points, and reduces
subjectivity, and worry. From a funds management point of view, well-defined
rules reduce key man risk, and allow for using quantitative techniques to improve
model performance.