If you are a day trader, swing trader, or long term investor it is important to understand relative strength. Relative strength is the strength of an equity compared to the major stock indexes. This reading will help you tell if a stock can trade sharply higher or lower in the time frame that the equity is being viewed.
Here is an example, if you are a day trader this morning and you see the PowerShares QQQ Trust (NASDAQ:QQQ) trading higher on the session, but a stock such as Netflix Inc (NASDAQ:NFLX) is trading lower by 2.0 percent then it is safe to say that NFLX stock is showing weak relative strength on the intra-day charts. When traders see a stock that has weak relative strength to the QQQ then it is important to note that if the QQQ starts to decline intra-day that particular stock with weak relative strength is likely to trade much lower. Stocks that have weak relative strength are already signaling to the trader that they do not have institutional sponsorship in the near term.
Lets take a look at another example. Today, the PowerShares QQQ Trust (NASDAQ:QQQ) is trading higher by $0.22 cents a share. This is not a big move higher, but the QQQ is making new 52 week highs on the daily chart. Then you have stocks such as Amazon.com (NASDAQ:AMZN), and Baidu Inc (NASDAQ:BIDU) trading sharply below their daily chart highs, this tells us that these stocks are signaling weak relative strength on the daily charts. Should the QQQ top out then it would be prudent to expect stocks such as AMZN, and BIDU to trade lower and lead the declines in the market.
Relative strength also works in the opposite way when an equity signals strength. At this time, Cree Inc (NASDAQ:CREE) has been a stock that is signaling strong relative strength. Should the QQQ trade higher we would expect CREE to trade higher along with the QQQ. Today, CREE stock is trading higher by 2.65 percent, meanwhile, the QQQ is only trading higher by 0.36 percent. In other words, CREE stock has strong relative strength in the market. Individuals will be better served by using relative strength when trading in the stock market.