Tuesday, July 3, 2007

Relative Strength and the TSX

Calculating relative strength is done simply by dividing the security you are interested in by a major index to see whether it is outperforming or under performing the index. In this case, the security that is of interest is XGD and the major index is the TSX, Canada's main stock index. Keep in mind that this has nothing to do with the RSI technical indicator that appears on the top of all my charts. That is something totally different.

Anyway, the chart below is a weekly chart of XGD divided by the TSX, so when the line is rising XGD is doing better, and vice versa. Beneath the relative strength line is a chart of XGD by itself. This chart generates excellent sell signals when the RSI of the relative strength line goes into overbought territory, and then leaves overbought territory. The reverse is also true when the RSI goes into oversold territory.

I have outlined some of these occasions with circles around the RSI and lines pointing down to the XGD chart to show how a bounce is usually imminent at these times. There are other times that this chart generated signals, but I thought 4 examples was enough to drive the point home. You see for yourself that signals generated resulted in a bounce in XGD 100% of the time.

One other aspect of this chart is that the deeper RSI goes into overbought/sold territory, the greater the resultant bounce in XGD. That being said, if you notice in the above chart, the RSI indicator presently is deep in oversold territory. This suggests to me that a very large upward move in XGD could be in the cards.

However, since these are weekly charts, signals generated take longer to manifest, and, in this case, RSI still has to leave its oversold range to trigger the signal. It will probably be necessary to wait a couple of months to really be able to tell if the signal generated here was a valid one.

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