How to Spot Market Leaders with the Relative Strength Line

“Top-performing stocks will lead the broader market averages at important turning points. As a bear market is bottoming, leading stocks, the ones that best resisted the decline, will turn up first and then sprint ahead – days, weeks, or even months before the Dow, S&P, and Nasdaq indexes put on their running shoes. These leading names will break into new high ground while the major indexes are just starting to come off their respecting lows.”

 – Mark Minervini, Stock Market Wizard

What is the Relative Strength Line?

Outperforming the market, outperforming the other stocks, and outperforming the peer group are the characteristics that define a leader. These companies are able to grow their sales, earnings, and margins the fastest.

The relative strength indicator, Relative Strength Line or RS line shows the strength of the stock compared to an index like the SPX500. If the line is making new highs, that means that the stock is outperforming the index. Even if the stock price is falling, if the RS line flattens or rises, that means that the index is falling harder. But when the RS line goes down, the base security outperforms the stock. We can find this indicator in many of the charting services, along with the stock’s price, moving averages, etc. The line is derived by dividing the stock price by the S&P 500 Index value.

Do not get confused – Relative Strength Line and RSI (Relative Strength Index) are not the same indicator.

Actually, RSI is a difference of perspective. The Relative Strength Line is showing the performance of a stock in comparison to the index, another stock, or some kind of benchmark, while the RSI is showing the performance of one stock in comparison to the recent performance of the same stock.

How to use the Relative Strength Line to spot the market leaders

Breakouts

The best scenario is to see the RS line making a new high before the stock breakout, but it is also good if the RS line makes a new high along with the stock breakout. One of the many examples is the Chinese automobile manufacturer Nio who’s RS line went up even before the stock breakout. From that point, the stock price went up more than 100%.

Source: TradingView

Market corrections 

When the whole market falls into a correction, there are stocks that are rising or at least going sideways. At the same time, their RS lines are going to rise in most cases. Those companies are supposed to be the next market leaders. Nvidia Corporation is one example. While the whole market fell into strong correction caused by Covid-19, the stock price of the company was declining at a slower rate than the S&P 500. From the RS breakout point, the stock price rose more than 150%.

Source: TradingView

Conclusion

True market leaders will always show improvement in their relative strength. Actually, they emerge from consolidation around the time the index is coming off a bear market or a correction low, in most cases. As the bear market is bottoming, leading stocks that best resisted the decline will turn up first and breakout from their bases. Buying stocks that outperform the market may increase chances of achieving gains.

Toni Lazarev is an eToro Popular Investor. He has a Master’s Degree in Monetary Economics, Finance and Banking and several other investment-related certifications. His investment strategy is aimed at outperforming the S&P 500 index on a yearly basis. 

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