Relative Strength Ranking

RELATIVE STRENGTH RANKING RELATIVE STRENGTH RANK IS NOT RSI, (or Relative Strength Index), where the stock is compared against itself, other similar industries or sectors or indexes... This is a measure of price performance of the stock during the previous 12 months AGAINST THE ENTIRE MARKET IRRESPECTIVE OF EXCHANGE. If we have a stock that has been ranked as 80 or better, that means that this stock viewed from the perspective of price outperformed 80% of ALL other common stocks in the entire database during the last year, (previous 52 weeks). You can use the Stock Screener on over 10,000 stocks for relative strength at StockTables.com The Pitbull Investor Stock Trading System utilizes Relative Strength RS Rank as one of the main criteria for a stock buy signal. This is an extremely powerful stock screen technique whose importance lies in its ability to, many times, anticipate moves BEFORE they happen..... As an example, many times a rapidly appreciating stock will continue to improve in a positive market, but its Relative Strength Rank will begin dropping, which means that there is a hidden loss of momentum masked by the favorable price increase. In reality the stock is not keeping up with the rest of the market; not even coasting on the free ride given by rising indexes like the DOW,S&P or NASDAQ. This occurs many times just before the stock "rolls over" and begins to head south, so many times you can exit a position while it is peaking instead of waiting to accept an 8 or 10% loss off of peak price. Conversely, in a poor declining market, a stock that steadily improves in RS RANK, even though its price may not be changing can indicate a true underlying strength, beating all other stocks, and a broad market rally will see these stocks take off faster and with greater momentum than market laggards. When you select RS Strength Rank from the Criteria menu you can then click on "ALL" which means that you will accept all rankings, or any of the graduated selections below. As an example, clicking on "80+" means that you will only accept screens of stocks which have 80 or greater relative strength. Conversely, if you were to choose "<30" you would be looking for stocks which were performing worse than 70% of the market.

You will find that our Relative Strength Rank does not exactly match those of financial newspapers, TeleScan© or Telechart© who also provide their own proprietary rankings. Indeed you will see vast differences between most of these services because of the way and the frequency with which they do their updates. Some sources only update once a week, or even once a month, while others update nightly as we do. The source that we have used for our Pitbull Investor© Selections for the past 12 years has been a manual screen of the daily financial newspaper. Now we use Stocktables every day along with the Stock Market Crash Index SO HOW DO RANKINGS?

WE

COMPUTE

OUR

RELATIVE

STRENGTH

TeleScan© and Telechart© all have their own closely held methods for computation of rankings. We have spent more than a year and a half developing our own proprietary algorithms which we believe to be superior. We started with a multi -year study conducted by members of the Toronto Stock Exchange, (Foerster, Prihar & Schmitz in their article "FPS Quarterly Weightings"), in developing their own method for computing RS Rank for the TSE. We chose this starting point because it was a published paper which revealed 4 different methods they were exploring with over 30 years worth of data. Based upon that study we continued our own research to more even-handedly evaluate the dramatic inequities induced in the market by stocks that were less than one year old or that had had dramatic near term volatility. The results we believe, speak for themselves, in the form of a truer picture of a stock's position in the marketplace. Like most others, we give more weight to

current price performance and less weight as we look at data that is aging, but that is where the similarity stops. As an example, we do not consider a stock that has gone from $10 to $100 and back to $80 to be the same as a stock that has gone from $10 to $80 and held its position. The stock that has had a 20% recent loss is ranked very low because of its current performance. In other Ranking systems it would take many weeks for this effect to come to parity where we can do it in just a day or two showing market turns much more rapidly before you lose 10 or 20% on your investment.

Relative Strength Rating Pinpoints A Stock's Power Everything in the stock market is relative. You want to buy stocks that are, relatively speaking, better than others. You want strong gains relative to the market. You'd like to be able to achieve all of this with relative ease. Two helpful tools on all three counts are IBD's Relative Price Strength Rating and the Relative Strength line. The RS Rating gauges a stock's performance vs. all other stocks in IBD's database over the past 12 months. Stocks like Mellanox Technologies (MLNX), with a 99 rating, have outperformed 99% of all stocks tracked by IBD over the past 12 months. IBD Chairman and founder William O'Neil says RS Ratings are similar to fastballs thrown by the best pitchers. "The average big league fastball is clocked at 86 miles per hour," O'Neil wrote in "How to Make Money in Stocks." "The best pitchers throw 'heat' in the 90s. An RS rating of 90 or better means a stock is already outperforming 90% or more of the market — even before possibly breaking out and starting its run. But like any other measure, a high RS Rating doesn't guarantee a winning run; it alone is not a buy signal, but simply one element helping you increase the odds of making money. A stock that has sprinted straight up for weeks or months is likely to hold a high RS rank. But it will often be extended, with no real buy point in sight. The trick is to find a stock that has managed to build or maintain a high RS Rating while basing.

The Relative Strength line gauges a stock's performance vs. the S&P 500 index. A rising line means the stock is outperforming the broader market. That's good. What you ultimately want to see is a stock near a buy point, showing a high RS Rating (say, 90 or better) with an RS line that in most cases is near or breaking to new highs. IBD research shows, from 1950 through 2008, the average RS Rating of the best-performing stocks just prior to their winning runs was 87. You can find RS Ratings in numerous places in IBD and at Investors.com. In an IBD chart, the RS line is painted blue and usually found under the price bars. Take a look at the charts for Mellanox. It had the combination of a top-shelf RS Rating and an RS line moving to new highs just before it broke out June 11. Or compare Apple (AAPL) and Priceline.com (PCLN) — both climbing the right side of three-month bases. Apple's RS Rating is a 93, down from 96 five weeks ago. Its RS line has inched up and is leaning toward a new high. Priceline's RS Rating has held steady near 88 for the past five weeks. Its RS line has ebbed, however, and is well below its April high. Keep an eye on the RS line as leading stocks climb the right side of their respective bases.

Momentum Trading [Part 1 of 3] By Dr. Bruce Vanstone Introduction

The purpose of this 3-part series of articles is to provide information about the potential benefits of momentum investing. In this series, I will try and explain what momentum is, the potential returns available to momentum investors, and the way that Porter Capital combine mechanical, rules-based strategies with the momentum effect to deliver benefits to investors. The 'premier' anomaly

Since its initial discovery by DeBondt & Thaler in 1985[1], the momentum effect has been documented and researched in many markets worldwide. Many traders and investors would know of the academic notion of the ‘efficient’ market, and the implication that this efficiency has on the ability of investors and traders to earn profits.

What you may not be aware of is that the father of the ‘efficient market hypothesis’, Eugene Fama, refers to momentum as “the premier unexplained anomaly”[2]. In other words, the success of momentum based investing is regarded by many as an exception to the efficient market hypothesis. What is it?

In its simplest terms, momentum refers to buying stocks which exhibit past overperformance. Research shows that stocks which have exhibited strong performance over some defined historical period, have a tendency to continue to exhibit strong performance for some number of future periods. It means that investors can potentially hitch a ride on strong momentum stocks. In part 2 of this series, I will use simulations to explore the potential risks and rewards of the momentum approach. A Typical Momentum Trade

The typical momentum trade has a history of clearly defined direction and strength. Figure 1 shows a chart of price activity for ALL (Aristocrat Leisure), from August 2004 to April 2005. During late August 2004, there is a clear price breakout on very heavy volume. This marks the start of the momentum opportunity. Over the next few months, the price activity demonstrates clearly defined direction.

Is it credible?

The momentum effect has been widely researched and documented in both the international and Australian equity markets. For example, Rouwenhorst[3] tested momentum strategies in 12 European markets using data from 1980 to 1995, and found that momentum returns were present in every country, and their effects lasted for approximately one year. Griffin et al.[4] found support for the profitability of momentum investing in over 40 countries, and concluded ‘Globally, momentum profits are large and statistically reliable in periods of both negative and positive economic growth’. Momentum has been thoroughly researched in virtually all of the worlds equity markets. Momentum effects have also been documented in other asset classes, such as foreign currencies[5], commodities[6] and real estate[7]. It is fair to say that the momentum effect appears to be one of the most beneficial effects for investors. Thorough research appears to indicate that momentum based investment does not increase investment risk, and that momentum effects are present during both economically good and bad cycles.

When does it work best?

Like all investment approaches, momentum investing is subject to the vagaries of the investor. For many investors, poor returns are not so much a function of their investment strategy, but of their own implementation of that strategy. All investment strategies benefit from the increased discipline and accountability that mechanical, rule-based trading brings, particularly during difficult investment cycles. I will discuss this topic in more detail in the third part of this momentum series. Introduction

This article is part 2 of a 3-part series. In this article, I will focus on using simulations to demonstrate the potential risks and rewards of the momentum approach. In the final part of the series, I will discuss the way in which investors can benefit from rule-based approaches to investment. Creating Momentum Simulations

The results presented in this article are a quick demonstration of the potential of the momentum effect for Australian investors. I like to use simulations as they provide an excellent opportunity to see how well a strategy could have performed in the past. Simulations are also useful because they can give some clues as to how a strategy may perform in the future. However, we must always remember that past performance is no guarantee of future performance. The simulation results in Table 1 have been created by calculating momentum on a historical rolling monthly basis for each member of the ASX200, and holding the top group of stocks each month. The data used contains delisted stocks, and is adjusted for survivorship bias as and where possible. Both simulations assume the same starting capital and account for transaction costs and slippage. The simulations cover the 10 year period from 2000 to 2009.

Applying Simulations to the ASX200

Table 1: Simulations of the Momentum Effect for Australian Investors

Historical Momentum Period

Risk (Max DD%)

Reward (APR%)

ASX200 benchmark Risk (Max DD%)

ASX200 benchmark Reward (APR%)

12

-60.07%

18.54%

-53.13%

4.76%

The columns contained in the table are explained below: Historical Momentum Period

The number of months over which historical momentum was measured

Risk (Max DD%)

Risk as measured by the maximum drawdown

Reward (APR%)

Reward as measured by APR (annual percentage rate)

ASX200 benchmark Risk (Max DD%)

Risk as measured by the maximum drawdown in the equivalent benchmark (XJO)

ASX200 benchmark Reward (APR%)

Reward as measured by APR in the equivalent benchmark (XJO)

Figure 1 shows an equity graph plotting a simulated portfolio versus the ASX200 (XJO) index portfolio.

Conclusions we can draw from this

In the first article of this series, I pointed out that the momentum effect appears to be one of the most beneficial effects available to investors. The results in Table 1 and Figure 1 clearly confirm this observation. The results above also confirm that to capture the benefits of a momentum approach, investors do not need to trade frequently, or with huge sums of capital, or in high-frequency timeframes. Instead, what is required is a disciplined, rulesbased approach to investment, and a strong focus on risk management. Although the momentum approach has slightly higher maximum drawdowns than the ASX200, the "potential" returns are substantially higher. Clearly though, investing using momentum alone is not a holy grail for investors! However, these results confirm that the momentum effect could be used to form the basis of an actively managed investment strategy, one that focused on trying to capture some of the outperformance, while still keeping an eye on risk. In the third part of this series, I will discuss the benefits to investors of mechanical, rules-based trading approaches. Many investors receive sub-standard investment returns, particularly when managing their own capital. In some cases, it is not the strategy itself, but the way it is being implemented which is at fault. If you find yourself attempting to second-guess the way you trade, or you are unsure how to react during periods of market turmoil, then it is likely that you could benefit from the increased discipline and accountability that mechanical approaches can deliver. Introduction

This article is part 3 of a 3-part series. In this final article, I will summarize the key characteristics of investing using momentum based approaches. I will also discuss some approaches to managing risk in momentum models, and the benefits investors can expect when investing with rules-based funds. Key Characteristics of Momentum Approaches

Perhaps one of the main benefits of the momentum approach is that it actually makes sense! It is not overly complicated to understand, it doesn't rely on split second timing, and it doesn't need huge sums of money to implement. From a quantitative point of view, momentum trading also carries a number of clear benefits. It is simple to quantify, it is non-subjective, and it is robust to parametric modelling changes. The momentum approach also has academic

credibility, and is the subject of ongoing research by some of the worlds best finance academics. The simulations in Part 2 showed that although there is slightly more "raw" risk than pure index investment, there is the potential for substantially higher returns. It is precisely this possible mismatch between risk and reward which qualifies momentum as an approach worth further study. It's no wonder academics call momentum, "the premier anomaly"! Managing Risk

Fortunately, there are a number of ways to manage risk that fit with the momentum approach. Distinguished academics like Andrew Lo have published useful research on the potential benefits of stop loss structures on momentum investment, demonstrating, at least in theory, that stop-losses can be of benefit to momentum based systems [1]. Other academic studies have investigated approaches like long-short investing, and hedging, which are techniques that have traditionally been used to reduce trading risk. Another way of managing risk is to focus on investing when momentum models work the best. The time that momentum models outperform is when there is a clearly defined direction for the overall stockmarket. When the market direction tends to be sideways, it may be better to convert a momentum portfolio back to cash. In the shorter term, this may increase the number of months when small losses occur. However, in the longer term, it will help preserve capital during periods when there is no real expectation from the momentum approach. This ensures that when the market clearly establishes its overall direction, the investor is ready and able to take advantage of it. This is the approach employed by Porter Capital Management. I have included 2 graphs of quarterly returns for the simulation performed in article 2 of this series. The first graph shows the effect of keeping a momentum portfolio fully invested. The second shows the benefits derived by converting the portfolio back to cash when the market shows no clear direction. It is clear in the second graph that several of the quarterly returns have been shifted in a positive direction.

Figure 1: Portfolio fully invested

Figure 2: Portfolio converted to cash when market 'directionless' Perhaps the most important consideration when using a momentum based approach is the idea of using models and rules to frame the way risk and returns are managed. Research tells us that to be successful in trading and investing requires a well defined plan, which encompasses not only entry and exit decisions, but also covers risk and money management. Having such a plan helps investors cope with the inevitable volatility that markets bring, especially during times when financial markets are under stress.

Importance of rules-based investment

For the average investor, trading and investing are difficult propositions. The average investor needs to invest a significant amount of time to develop the level of market expertise required to be successful. As I have suggested in Part 2, many investors receive substandard investment returns, and in many cases, it may well be that the investors own behaviour is to blame. Research tends to show that investors have a number of well documented behavioural problems! For example, it has been shown that investors tend to overtrade their accounts to their detriment [2], and, that although investors may pick good stocks they tend to sell winners too early and sell losers too late [3]. Rules based investment allows the investor to specify the conditions under which he will buy or sell stock, and how much stock will be bought or sold. Using rules to quantify your trading decisions leads to clear entry and exit points, and reduces subjectivity, and worry. From a funds management point of view, well-defined rules reduce key man risk, and allow for using quantitative techniques to improve model performance.