Nov 30: Metastock Part 2: Relative Strength Comparison (RSC) The Key Success Tool In Trading By Stock Market Sectors

by David Jenyns on November 30, 2005

In Part 1 of this article, I discussed the importance of sector analysis, and the use of the Relative Strength Comparison to identify the best performing securities in the best performing sectors. In Part 2, I will show you how to use MetaStock to find these securities.

To create an exploration that uses the RSC you need to first open a chart of the base index (e.g. S&P/ASX200 for the Australian market, or the Straits Times Index for Singapore) that you will be using for the comparison between market sectors. Once the chart is open, left click on the price plot to highlight the price information. You`ll know it`s selected when a series of small dark squares appear on the price plot. It`s important to note that each time you wish to do an exploration of this kind, you must first choose your base index.

Next, open the Explorer dialog box and select `new`. Name the Explorer the `MetaStock Guide Sector Analysis`. Then click within `Column A` and enter the following formula:

ROC(MOV((C/P),13,S),1,%)

This formula calculates the rate of change, as a percentage, in the relative strength of the sectors against the base index over a 13 week period. It may seem complex but let`s break it down into manageable parts, beginning with the inner-most brackets first:

C/P is the relative strength (or RSC component) of the tested sectors vs. the base security.

The way it`s calculated is by dividing the closing price of the sector, by `P`, where `P` is the base index that you highlighted before creating this exploration.

(MOV((C/P),13,S) calculates the moving average of the RSC over a 13 week period.

ROC(MOV((C/P),13,S),1,%)calculates the rate of change of the moving average of the RSC, in other words, the amount the sector has moved up or down as a percentage.

Looking back at MetaStock, note that you didn`t enter anything into the filter tab. This is because you only use the filter tab when you`re looking to remove certain securities from your exploration results. Since you`re not looking to exclude any sectors, but to rank all the sectors, you should leave the filter blank.

Before running this exploration you must check the time period. To do this click the `Options` button at the bottom of the `Exploration Edition` dialog box and then select the radio button marked weekly. Click `OK` twice to return to `the Explorer` dialog box.

Now you`re ready to run the exploration, so click `Explore`. The `Select Securities for MetaStock Guide Sector Analysis` dialog box will appear, and you must select the directory with your market sectors in it. This directory should be stored with your other market data and is usually one directory up from your equities folder. However this can vary, depending on who supplies your data.

When the market sectors are highlighted, click `OK`. When the exploration is complete the `Exploration Completed` dialog box will appear. Click the `Reports` button and to get a summary of the exploration. The results shown in `Column A` will give you the rate of change of the relative strength

Tip: By clicking the `Column A` heading you can arrange the results in ascending or descending order.

What Do these Results Mean?

The results of this exploration are fairly straightforward. A value greater than zero indicates that market sector is outperforming the base index. A zero indicates that the market sector is performing on par with the base index, while a negative number indicates the market sector is under-performing the base index.

Remember, a rising RSC value only indicates that the market sector is outperforming the base Index, it does not necessarily mean the sector is rising in value. Similarly, if the RSC is falling; it only indicates that that sector is under-performing the market index, the market sector may not be loosing value. Because of this, it is important to open the chart of the market sectors to analyse the trends.

This information on its own can complement your current trading. For example, you may decide to only trade securities which are in top performing sectors. Or, you could take it one step further and select the top five sectors and use the `MetaStock Guide Sector Analysis` explorer again. This time, however, you could compare individual securities against their respective sectors.

The difference between running this exploration and running the first one, is that the market index would now become the market sector chart; and the list of sectors would become the list of securities that make up the top performing sectors.

By following the same steps as before you could run five separate explorations and rank the securities against their respective sectors. The result would identify the top performing securities within the top five sectors.

The final stage in this top down analysis would be to open all the charts that have made it to the shortlist. You can whittle this list down further by eliminating those securities that aren`t in an up-trend or those that are too thinly traded. In the end you`d be left with the cream of the crop, between five and ten securities. These securities will be the best performing securities in the best performing sectors.

These securities should now be placed on your watch list. I suggest you don`t race out and buy them. Instead, wait for an appropriate trigger to enter. This could be based on candlestick patterns, and/or favourable combinations of other bullish indicators.

The RSC exploration is a great way to utilise the power within MetaStock. It can be an extremely effective tool in identifying profitable trading opportunities. The downside for this type of exploration is that it is not a complete system on its own and would need to be combined with other entry, exit and money management rules. However, you can create a solid trading system that would benefit greatly from including sector analysis.

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