T2W Trading Community

3. RELATIVE STRENGTH -
The next important factor to check out, in order to narrow down our list of potential buys is the relative strength (RS). I don’t mean the RS of one share against another or even of a share’s current performance against a previous period. No, it is the RS of the breakout share against its encompassing market index. In this way we get a view of the share’s performance as against the overall market. It is obvious, isn’t it, that even if a share is rising in price it can show poor performance against its index. Thus if a share rises by say 10% while the FTSE 250 index (in which it resides) rises by 20% then it is lagging badly even though it is rising.

Not only is it not a leader but it is probably being pulled reluctantly higher. Therefore, when the market turns over, there is a good chance that the share will drop like a stone.
The formula for relative strength is simple :

                                                   Price of share
                                                  Price of market index        X 100 
   
It is the use of the RS function that allows us to sort the also-rans from the top performers so that we only have the potential big winning shares in our portfolio.

Look at the chart of Cairn Energy (cne); the relative strength turns positive at the crucial times (marked ‘1’ and ‘2’) – just before the other signals click into place and the two buy signals appear (at points ‘A’ and ‘B’). Note, again, the volume increases.

Bringing these three together forms the - 

THE TRIPLE CONFIRMATION PATTERN -

The first factor for any prospective Long position is the entry into a Stage 2 uptrend.
The second is the requirement for the Relative Strength indicator to have swung into a positive position (this is very important for distinguishing between the great buys from the simply good buys).

The third factor is the requirement for impressive volume (which is a key ingredient for a super winner).

Only when all three are ‘in position’ will you have a truly great prospect for super-charged growth. This diagram shows the required triple confirmation pattern that can lead to explosive growth -