Relative Strength Ratios Between a Sector and the Market

Type the sector fund’s symbol, a slash, and the index symbol into your charting tool. The line that comes back is the relative strength ratio: the fund’s price divided by the index, plotted day by day. Its level means almost nothing on its own. Its direction means a lot. When the line climbs, the sector is doing better than the market. When it falls, the sector is doing worse, and that holds even when both prices are rising, which is exactly the case that a plain price chart hides from you.

Building the ratio

Any pair of prices works, as long as you keep the order fixed. Sector on top, market underneath. You can use the index level itself or a broad index fund, and the shape of the line comes out the same either way, since only the scale changes.

Take a hypothetical sector fund at $30 with the index at 200. The ratio is 30 / 200 = 0.150. Nobody cares about 0.150. Watch where it goes next.

Measuring the change

Two months later, the fund is at $33.39 and the index at 210.

Subtract the returns and you get 6.3 points. The ratio says 6%. The ratio divides one growth factor by the other. Subtracting returns gets close for small moves and drifts further off as moves grow, so when you rank sectors, rank them on the ratio change and keep the method the same for all of them.

Now a less comfortable case. The fund gains 3% over a month while the index gains 5%. Both lines on the price chart point up. The ratio falls, though: 1.03 / 1.05 = 0.981, a 1.9% drop in relative strength. The sector is going up and losing ground at the same time, and a trader holding its stocks is getting a smaller share of the rally than an index fund would have delivered.

Reading direction

Short stretches of the ratio are noisy. A single day’s move can come from one earnings report or one rate headline. So smooth it. Add a moving average of the ratio itself, something like 10 weeks on a weekly chart or 50 days on a daily one, and read the ratio against that line. Above a rising average: leading. Below a falling one: lagging.

A second, rougher test is the pattern of highs and lows. A ratio making higher highs and higher lows is in an uptrend of relative performance. That’s the same reading you’d apply to a price chart, and the relative strength line entry works through it for single stocks.

Reading the turns

The most useful moments come at the turns. A ratio that has fallen for months, flattens, and then crosses above its average is the early sign of a sector moving from laggard to leader. The reverse, a long-rising ratio that rolls over and breaks below its average, is the first warning that leadership is passing to someone else.

Turns are also where the ratio fools you most often, since a crossing that reverses within days looks identical to a real turn at the moment it happens, and nothing on the chart tells the two apart until later, sometimes weeks later, when the ratio has either kept going or slid back under the line. So wait. Let the ratio hold beyond its average for more than a bar or two. Some false starts still get through.

Putting the ratios to work

One ratio tells you about one sector. Chart all of them over the same window and you can rank the whole market by relative strength, from the sector gaining ground fastest to the one losing it fastest. The same method ranks single stocks, as ranking stocks by relative strength shows, and if you need a refresher on what drives each group, go back to the stock market sectors. The next lesson, rotating a watchlist toward the leading sectors, turns that ranking into a weekly routine.