Relative strength investing
You just got your graded math test back, and you only scored 60%. What an idiot you are, right? Depends… An idiot compared to what? If the 19 other people in your class scored under 50%, maybe you’re not such a moron after all. Next test: Wow! You scored 90%! You’re a genius. But wait a minute… This time, the 19 other people in your class scored 95% or higher. So, are you really as smart as you thought you were? The answer to all of this lies in relativity. The categorization of your performance as ‘success’ or ‘failure’ really is relative to your environment. And this is a good way to look at things when you’re investing, as well.
Using ‘relative strength’ (RS) as a benchmark is simple: When evaluating the strength of your investments, make sure that you always consider the current market. So, maybe you invested in Stock X, and it’s now plummeting, and you’re losing a ton of money. But what’s the rest of the market doing? Did it drop more than Stock X? If so, maybe your investment wasn’t so bad. After all, if you’re a frequent investor, you were probably going to invest in something, right? And if you had instead invested in Stock Y or Stock Z, which are doing even worse, then you would have lost even more money! Even though it sucks to be you, Stock X still turned out to be the best bet – it has good RS, even though you didn’t profit.
And same thing applies the other way around: You invested in Stock A, and it went up – congrats, you made money! But wait… The market average is up even higher than Stock A. Turns out that Stock A was, in fact, a mistake, because you could have instead invested in Stock B or Stock C, and you would have done even better. Always remember this: In stock trading, a penny not earned is a penny lost. The RS of Stock A is actually quite low, when compared to all of the others, currently.
The bottom line is this: If you’re able to invest in stocks with high RS – even if they suffer losses from time to time – you’re still going to come up ahead in the long term, and you’ll most certainly do better than the vast majority of other investors, by the very definition. Following the RS model very often helps the traders that adhere to it make more money than all other investors. So, invest wisely, and don’t beat yourself up over every loss (or pat yourself on the back over every profit). Remember, it’s all relative.