Trading Strategy: Buy Relative Strength

In contrast to the previous strategy, where we waited until there was a consolidation or retracement in the trend to be sure that we traded at a suitable low point, an alternative way to profit from an uptrend is to buy into the strongest of the strong, without waiting for a dip or retracement. In this case, the steps are –

  • establish that the market is going up
  • check that the sector is going up
  • the particular financial security is going up

Now instead of waiting for a dip in the price to define our entry, we can choose to check first that the trend is likely to continue, and then place a trade. In this case you would –

  • check the strength relative to other securities, making sure that it is one of the strongest
  • calculate trade size and stoploss
  • enter trade long
  • exit trade if failed or on profit

The difference from the previous strategy is that you do not wait for a dip, but you do check that the security you are interested in is behaving strongly. If you want some starting figures for guidance, you could choose to define this by checking that the performance is better than the market by at least 10%, and better than the sector by at least 1% over the past week or two. You should make sure that whatever figures you use you are going to be happy with them, and you can verify your own levels by backtesting.

You can exit this trade on a protective stop set below the lowest level for the past few days, or if in profit you can set a trailing stop, or exit if the security falters and fails to outperform the market for a couple of weeks. Once again you should use your technical analysis  knowledge to select likely target and stop loss levels, and make sure that the reward/risk ratio is favourable.

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