Relative Strength Ranking

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RELATIVE STRENGTHRANKING

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 12months AGAINST THE ENTIRE MARKET IRRESPECTIVE OF EXCHANGE.If we have a stock that has been ranked as 80 or better, that means that this stockviewed from the perspective of price outperformed 80% of ALLother commonstocks in the entire database during the last year, (previous 52 weeks).

You can use theStock Screeneron over 10,000 stocks for relative strength at

StockTables.com

The Pitbull InvestorStock Trading Systemutilizes Relative Strength RSRankas one of the main criteria for a stock buy signal.

This is an extremely powerful stock screen technique whose importance lies in itsability to, many times, anticipate moves BEFOREthey happen.....

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

Conversely, in a poor declining market, a stock that steadily improves in RSRANK, even though its price may not be changing can indicate a true underlyingstrength, beating all other stocks, and a broad market rally will see these stockstake 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 graduatedselections below. As an example, clicking on "80+" means that you will only

accept screens of stocks which have 80 or greater relative strength. Conversely, ifyou were to choose "


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You will find that our Relative Strength Rank does not exactly match those of

financial newspapers, TeleScan or Telechart who also provide their ownproprietary rankings. Indeed you will see vast differences between most of theseservices 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 othersupdate nightly as we do.

The source that we have used for our Pitbull Investor Selections for the past 12years has been a manual screen of the daily financial newspaper. Now we useStocktables every day along with theStock Market CrashIndex

SO HOW DO WE COMPUTE OUR RELATIVE STRENGTH

RANKINGS?

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

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

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 lessthan 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 astock's position in the marketplace. Like most others, we give more weight to
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current price performance and less weight as we look at data that is aging, but thatis where the similarity stops. As an example, we do not consider a stock that hasgone from $10 to $100 and back to $80 to be the same as a stock that has gonefrom $10 to $80 and held its position. The stock that has had a 20% recent loss isranked 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 justa 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 allof this with relative ease.

Two helpful tools on all three counts are IBD's Relative Price Strength Rating andthe Relative Strength line.

The RS Rating gauges a stock's performance vs. all other stocks in IBD's databaseover 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 12months.

IBD Chairman and founder William O'Neil says RS Ratings are similar tofastballs 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 moreof the marketeven before possibly breaking out and starting its run.

But like any other measure, a high RS Rating doesn't guarantee a winning run; italone is not a buy signal, but simply one element helping you increase the odds ofmaking money.

A stock that has sprinted straight up for weeks or months is likely to hold a highRS rank. But it will often be extended, with no real buy point in sight. The trick isto find a stock that has managed to build or maintain a high RS Rating whilebasing.
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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 RSRating (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 Ratingof 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 anIBD 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 RSRating 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 rightside of three-month bases. Apple's RS Rating is a 93, down from 96 five weeksago. 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 linehas ebbed, however, and is well below its April high. Keep an eye on the RS lineas leading stocks climb the right side of their respective bases.

Momentum Trading [Part 1 of 3]

ByDr. Bruce Vanstone

Introduction

The purpose of this 3-part series of articles is to provide information about thepotential benefits of momentum investing. In this series, I will try and explain

what momentum is, the potential returns available to momentum investors, andthe way thatPorter Capitalcombine mechanical, rules-based strategies with themomentum effect to deliver benefits to investors.

The 'premier' anomaly

Since its initial discovery by DeBondt & Thaler in 1985[1], the momentum effecthas 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 andtraders to earn profits.
http://finance.yahoo.com/q?s=aaplhttp://finance.yahoo.com/q?s=aaplhttp://finance.yahoo.com/q?s=aaplhttp://finance.yahoo.com/q?s=pclnhttp://finance.yahoo.com/q?s=pclnhttp://finance.yahoo.com/q?s=pclnhttp://astore.amazon.com/incrediblecha-20/detail/1906659583http://astore.amazon.com/incrediblecha-20/detail/1906659583http://astore.amazon.com/incrediblecha-20/detail/1906659583http://www.portertrading.com/homehttp://www.portertrading.com/homehttp://www.portertrading.com/homehttp://www.portertrading.com/homehttp://astore.amazon.com/incrediblecha-20/detail/1906659583http://finance.yahoo.com/q?s=pclnhttp://finance.yahoo.com/q?s=aapl


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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 isregarded 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 strongperformance over some defined historical period, have a tendency to continue toexhibit strong performance for some number of future periods. It means thatinvestors can potentially hitch a ride on strong momentum stocks. In part 2 of thisseries, I will use simulations to explore the potential risks and rewards of themomentum approach.

A Typical Momentum Trade

The typical momentum trade has a history of clearly defined direction andstrength. 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 pricebreakout on very heavy volume. This marks the start of the momentumopportunity. Over the next few months, the price activity demonstrates clearly

defined direction.


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Is it credible?

The momentum effect has been widely researched and documented in both theinternational and Australian equity markets. For example, Rouwenhorst[3] testedmomentum strategies in 12 European markets using data from 1980 to 1995, andfound that momentum returns were present in every country, and their effectslasted for approximately one year. Griffin et al.[4] found support for theprofitability of momentum investing in over 40 countries, and concluded

Globally, momentum profits are large and statistically reliable in periods of bothnegative and positive economic growth.

Momentum has been thoroughly researched in virtually all of the worlds equitymarkets. 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 beneficialeffects for investors. Thorough research appears to indicate that momentum based

investment does not increase investment risk, and that momentum effects arepresent during both economically good and bad cycles.


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When does it work best?

Like all investment approaches, momentum investing is subject to the vagaries ofthe investor. For many investors, poor returns are not so much a function of theirinvestment strategy, but of their own implementation of that strategy.

All investment strategies benefit from the increased discipline and accountabilitythat mechanical, rule-based trading brings, particularly during difficult investmentcycles. I will discuss this topic in more detail in the third part of this momentumseries.

Introduction

This article is part 2 of a 3-part series. In this article, I will focus on usingsimulations to demonstrate the potential risks and rewards of the momentumapproach. In the final part of the series, I will discuss the way in which investorscan benefit from rule-based approaches to investment.

Creating Momentum Simulations

The results presented in this article are a quick demonstration of the potential ofthe momentum effect for Australian investors. I like to use simulations as they

provide an excellent opportunity to see how well a strategy could have performedin the past. Simulations are also useful because they can give some clues as tohow a strategy may perform in the future. However, we must always rememberthat past performance is no guarantee of future performance.

The simulation results in Table 1 have been created by calculating momentum ona historical rolling monthly basis for each member of the ASX200, and holdingthe 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 thesame starting capital and account for transaction costs and slippage. Thesimulations cover the 10 year period from 2000 to 2009.


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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

(MaxDD%)

Reward

(APR%)

ASX200

benchmarkRisk (Max

DD%)

ASX200

benchmarkReward

(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 percentagerate)

ASX200 benchmark Risk(Max DD%)

Risk as measured by the maximum drawdown inthe equivalent benchmark (XJO)

ASX200 benchmark Reward(APR%)

Reward as measured by APR in the equivalentbenchmark (XJO)


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Conclusions we can draw from this

In the first article of this series, I pointed out that the momentum effect appears tobe one of the most beneficial effects available to investors. The results in Table 1and Figure 1 clearly confirm this observation.

The results above also confirm that to capture the benefits of a momentumapproach, 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 thanthe ASX200, the "potential" returns are substantially higher. Clearly though,investing using momentum alone is not a holy grail for investors! However, theseresults confirm that the momentum effect could be used to form the basis of anactively managed investment strategy, one that focused on trying to capture someof the outperformance, while still keeping an eye on risk.

In the third part of this series, I will discuss the benefits to investors ofmechanical, rules-based trading approaches. Many investors receive sub-standardinvestment 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 unsurehow to react during periods of market turmoil, then it is likely that you couldbenefit from the increased discipline and accountability that mechanicalapproaches 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 alsodiscuss some approaches to managing risk in momentum models, and the benefitsinvestors 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 actuallymakes sense! It is not overly complicated to understand, it doesn't rely on splitsecond timing, and it doesn't need huge sums of money to implement.

From a quantitative point of view, momentum trading also carries a number ofclear benefits. It is simple to quantify, it is non-subjective, and it is robust toparametric modelling changes. The momentum approach also has academic


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credibility, and is the subject of ongoing research by some of the worlds bestfinance academics. The simulations in Part 2 showed that although there isslightly more "raw" risk than pure index investment, there is the potential forsubstantially higher returns.

It is precisely this possible mismatch between risk and reward which qualifiesmomentum as an approach worth further study. It's no wonder academics callmomentum, "the premier anomaly"!

Managing Risk

Fortunately, there are a number of ways to manage risk that fit with themomentum approach. Distinguished academics like Andrew Lo have publisheduseful research on the potential benefits of stop loss structures on momentuminvestment, demonstrating, at least in theory, that stop-losses can be of benefit tomomentum based systems [1]. Other academic studies have investigatedapproaches like long-short investing, and hedging, which are techniques that havetraditionally been used to reduce trading risk.

Another way of managing risk is to focus on investing when momentum modelswork the best. The time that momentum models outperform is when there is aclearly defined direction for the overall stockmarket. When the market direction

tends to be sideways, it may be better to convert a momentum portfolio back tocash. In the shorter term, this may increase the number of months when smalllosses occur. However, in the longer term, it will help preserve capital duringperiods when there is no real expectation from the momentum approach. Thisensures that when the market clearly establishes its overall direction, the investoris ready and able to take advantage of it. This is the approach employed by PorterCapital Management. I have included 2 graphs of quarterly returns for thesimulation performed in article 2 of this series. The first graph shows the effect of

keeping a momentum portfolio fully invested. The second shows the benefitsderived by converting the portfolio back to cash when the market shows no cleardirection. It is clear in the second graph that several of the quarterly returns havebeen shifted in a positive direction.


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Figure 1: Portfolio fully invested

Figure 2: Portfolio converted to cash when market 'directionless'

Perhaps the most important consideration when using a momentum basedapproach is the idea of using models and rules to frame the way risk and returnsare managed. Research tells us that to be successful in trading and investing

requires a well defined plan, which encompasses not only entry and exitdecisions, but also covers risk and money management. Having such a plan helpsinvestors cope with the inevitable volatility that markets bring, especially duringtimes when financial markets are under stress.


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Importance of rules-based investment

For the average investor, trading and investing are difficult propositions. Theaverage investor needs to invest a significant amount of time to develop the levelof market expertise required to be successful.

As I have suggested in Part 2, many investors receive substandard investmentreturns, and in many cases, it may well be that the investors own behaviour is toblame. Research tends to show that investors have a number of well documentedbehavioural problems! For example, it has been shown that investors tend toovertrade their accounts to their detriment [2], and, that although investors maypick 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 whichhe will buy or sell stock, and how much stock will be bought or sold. Using rulesto quantify your trading decisions leads to clear entry and exit points, and reducessubjectivity, and worry. From a funds management point of view, well-definedrules reduce key man risk, and allow for using quantitative techniques to improvemodel performance.

Relative Strength Ranking

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