Investors trying to determine whether a stock is a good investment can compare the relative strength of a stock against the relative strength of an index. Relative strength is found by dividing the average gains of a security over a period of time by the average losses for that stock over the same time period. A stock with a higher relative strength than the overall index often represents a strong investment opportunity.
Look at the financial records for the price changes of stock for the previous two weeks. You can go back further if you want a longer view of the stock's relative strength, but a minimum of 14 days is enough. Write down the daily price changes for the stock in two different columns; compile price increases into a column titled "gains" and decreases into a column titled "losses."
Find the averages of both the gains and losses for the stock. Add the totals for the gains and losses columns; treat the losses as positive, and not negative, numbers. Divide the total of each column by 14, or the number of days or periods that you have compiled into these columns.
Divide the average gain of the stock by its average loss to determine the relative strength of that stock.
Perform these same calculations for an entire index to find its relative strength. Add the total of gains as well as the total of losses for the same time period, and find the average gain by dividing each total by the number of periods you are using to compare the stock to the index. Divide the average gain for the entire index by the average loss to find the relative strength of the entire index.
Compare the relative strength of the individual stock against the relative strength of the entire index. If the stock's relative strength is higher, it is performing better than the overall market for the time period examined. If the index has a higher relative strength, then the stock may be a poor investment compared to others in the market.
A stock's relative strength can be used to find its place in the relative strength index, or RSI. RSI is an indication of a stock's momentum in the market. To calculate RSI, add 1 to a stock's relative strength rating. Divide this figure from 100 (i.e.: 100/x). Subtract the total from 100 to find the stock's relative strength index rating. An RSI rating over 70 indicates that a stock is being overbought, while a rating under 30 means the stock is being oversold.
Items you will need
- Stock and index records for previous two weeks
- Pen and paper
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