lecture 9: Relative Strength & Flow of Funds Flashcards
Relative Strength
One of the oldest approaches of technical analysis, and still one of the most widely used
action of a stock, or a group of stocks, is often compared to the market as a whole, so that it can be determined whether or not the stock or the group is acting better than, or worse than the market in general
how to calculate Relative Strength?
calculated by a simple ratio, dividing one market by another
When the Relative Strength ratio is rising?
When the ratio is falling?
When the Relative Strength ratio is rising = the numerator price is stronger than the denominator.
When the ratio is falling = the denominator price is stronger than the numerator.
The presumption behind Relative Strength
that strength will continue, similar to how trends will continue
How to interpret relative strength
If the numerator is rising, you would buy the numerator and sell the denominator. If the opposite is true, you would sell the numerator and buy the denominator
can be used to determine intermarket relationships.
–> It can be used to compare investments, sectors, industries, index averages, commodities etc. to determine which is outperforming the other
The simplest (and most utilized) form of Relative Strength
when the daily (or weekly) close of as stock (or sector group) is divided by a market average or index, the latter being most often the S&P 500
A stock that is moving laterally while the market is trending lower will, by definition, possess a strong or weak relative strength curve
possess a strong relative strength curve
A stock that is moving laterally while the market moves laterally will possess flat, or in-line relative strength trend.
true or nah
true
Many times the technical analyst will use relative strength to determine future market leadership, or the potential loss of leadership
what could this mean at the end of bear market?
Groups that act well in the tail end of a bear market, often emerge as the new bull market’s leaders
Leaders in a bull market may show signs of losing their status if relative strength “divergence” begins to do what?
profile a mature trend
Relative strength is an important technical tool, but like any other technical tools RS analysis should probably not be a sole application
why?
it should be noted that, without utilizing any other technical disciplines, one could find a stock “topping” out while maintaining a strong relative strength curve — or it could bottom out while relative strength appears poor
While these two characteristics would more than likely be an infrequent development, it is nevertheless advisable to input other technical guide lines, like trend analysis, support/resistance analysis
Flow of Funds At the beginning of a major uptrend
investors are risk averse; they have only a small percentage of their financial assets in stocks and have a high percentage in bonds and cash.
Traders are either out or they are short, trying to exploit the downside
when is An uptrend is started?
how does this affect traders
started by investors, people with long-term horizons, willing to look beyond current uncertainties
They are motivated by price and value.
Traders, on the other hand, are motivated by the trend, and tend to gain greater and greater confidence as a trend persists
For supply and demand to work in any market, money must be available
what happens when it is not
When money is unavailable or expensive, the supply of stock increases as investors sell their stock to raise funds for other purposes
There are 4 major topics in the study of flow of funds
Money Available
Availability of Funds Not Currently Invested in the Market
The Cost of Funds
Influence of the U.S. Federal Reserve’s Policy on these variables
money available: MONEY MARKET MUTUAL FUNDS
This indicator shows the liquidity or illiquidity available to the stock market.
However, having large amounts of cash on the sidelines available for investment does not necessarily mean that the funds will be committed to the stock market, though it can be
According to Ned Davis Research (NDR) (p.197) a high level of money invested in money market mutual funds (13-week ROC above 17.9%) is viewed as what?
a contrarian indicator that the market will rally
Money Available: Margin debt
the amount of funds that customers at brokerage firms borrow to buy stocks
has historically been considered a contrarian sentiment indicator
theory behind Margin debt
when markets became speculative and attract the less sophisticated and less knowledgeable investors who began to trade on margin, the market was at a top
Money Available: secondary offerings
The number of secondary offerings is a sign of increasing supply of stock being sold on the market
considered bearish
The number of offerings is more important than the dollar amount, since the dollar amount can be skewed by a few offerings
why are secondary offerings bearish?
First, it is a sign that more supply is coming into the market, soaking up available funds.
–> This excess supply pushes prices down.
Secondly, the sellers who are usually insiders, are liquidating.
–> These insiders will try to sell at prices that they feel are relatively high
Funds outside the securities market: HOUSEHOLD FINANCIAL ASSETS
This includes a ratio of liquid family assets (cash, bank deposits, money mkt mutual funds, treasury bonds) to illiquid assets (pension funds, retirement accounts, mortgages, life insurance).
what does A ratio of liquid financial assets to total financial assets show us?
shows us how liquid families are in raising cash if they need it
The more liquid families are, the more they are able to invest in stocks
–> Therefore when household liquidity is high, this is favourable for the stock market, and when it is low, this is a negative for the stock market
Funds outside the securities market: Money supply
Increases in the money supply have been historically associated with what?
with increases in economic growth and productivity
Expansion in the money supply is a measure of potential demand for stocks