Momentum trading with relative strength as a guide

Momentum trading strategies favor using the trajectory of prior price action to determine where prices may be heading next. Those same strategies can be potentially enhanced by adding another layer of information: relative strength.

I don't mean relative strength as in the relative strength index technical indicator, though. Instead I'm looking at the relative strength (or weakness) of one asset vs another, often broader comparison.

Demonstrating relative strength: XLE vs SPY

For example, the energy sector is outperforming the S&P 500 this year, and we saw a resurgence of that strength begin anew in late August. As we saw relative strength build, it provided a signal that perhaps there was a rotation happening underneath the surface, where allocation was heading into energy and out of other areas of the market.

A ratio chart of XLE vs SPY
A ratio chart of XLE vs SPY

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