The RS (Relative Strength) concept
"Relative Strength" or RS is a widely used concept in technical analysis to compare the price performance of one security against the price performance of another security in order to choose which one of the two is to prefer over the other.
RS vs. RSI (Big difference)
This RS should not be confused with the very popular "Relative Strength Index" or RSI by Welles Wilder. The RSI is a single-security indicator which measures "overbought/oversold" conditions of that security where RS compares two different securities in order to facilitate a choice.
To avoid confusion, RS is often referred to as Comparative Relative Strength or Relative Strength Comparative etc.
Relative Rotation Graphs are based on this Comparative Relative Strength concept.
The formula to calculate Relative Strength is simple:
RS = Price of security A / Price of security B
The outcome of this formula is a (RS) line that usually is plotted in combination with the price chart of security A.
Relative Strength example for Consumer Staples sector
The chart above shows the price chart of the US Consumer Staples sector in combination with the Relative Strength line of the Consumer Staples sector against the S&P 500 index.
The interpretation of this Relative Strength line or "Raw Relative Strength" as I often call it is very straight forward. When the RS line moves up the Consumer Staples sector is outperforming the broader market and should be "overweight" in portfolios. When the RS line is moving down the Consumer Staples sector is under performing the broader market and should be "underweight".
A very good example of how this works can be seen in the period between the two dashed blue lines.
During that period the Consumer Staples sector is showing a nice steady up trend on the price chart but the Relative Strength line is moving down in a steady down trend.
The message here is that during that period the general market, as measured by the S&P 500 index, was rising at a faster pace than the Consumer Staples sector which therefore should be underweight in a portfolio.
As you can see the RS line pretty much looks like and behaves like a regular security price chart. This means that we can use all the tools in our technical analysis toolbox, like moving averages, trend lines, support/resistance etc, to analyse this RS line and make a call on its expected future direction.