The Price Relative Indicator is a way to judge how the stock, sector or index you are following is performing relative to any other stock, sector or index.
While the word “price” is in the name, it is only important in relation to the price of the stock, sector or index you are comparing it to.
That’s a key point and one that can be confusing when traders are first using the price relative indicator.
Let’s look at some charts to see how this indicator works.
Remember, this indicator gauges the relative performance – not the price.
Here we are looking at two indices. The Dow Jones Healthcare Index, which is the green line, and the overall market, as represented by the S&P 500, which is the orange line. Notice that from June to October, both indices were trending higher. We now look at the price relative line, the purple line in the lower pane, and we notice that it is sloped up. This means that health care is outperforming the overall market. If the symbol you are interested in is outperforming, you will always see that line sloped up. Now let’s move over to December. As we see, coming off the bottom in December, again both indices were trending higher. Now we look at the price relative line, and it is actually sloped down. This means that health care is now lagging the overall market. Remember, if the symbol you are interested in is underperforming the comparison stock, sector or index, the price relative line will slope down.
Let’s move on to another example, in the same timeframe. Here we are comparing semi-conductors, the pink line, and the overall market, again, which is the orange line.
Notice from November to the end of the year, while both indices were falling, we actually see with the price relative line that the semi-conductors were outperforming.
Then the market turned around, the price relative line is telling us that the semi-conductors were still outperforming and leading the overall market.
You often see this when in a falling market, the stocks that do best when the market turns around are also the ones that can lead.
There are numerous ways to use price relative to generate trading ideas.
One way is to compare a sector to the overall market. If the price relative line starts to slope up, it means that money is beginning to rotate into that sector, potentially signaling the beginning of an uptrend. You might choose to buy a sector ETF to take advantage of this move.
You can also compare a stock to its sector. This allows you to evaluate whether the stock you are considering is a leader or a laggard. It almost goes without saying that momentum traders prefer leaders.
Another use is to compare one broad area of the market to another such as comparing the price action of the small cap Russell 2000 to the large cap S&P 500.
This approach provides all sorts of useful information. For example, if the small cap stocks, which tend to have more of their revenues based domestically, start to outperform the large cap stocks, it could be an indication that the market is worrying about international trade issues which generally have an outsized effect on the large cap multi-nationals.
Finally, you can combine all these techniques mentioned above to drill down as much as possible. For example, by examining the various price relative studies you might find that the large cap stocks are outperforming the small caps and that healthcare is also starting to outperform. You could then build a screen to find a large cap, healthcare stock that is outperforming the sector.
To learn more about technical indicators and how to use them, check out all the other videos in this series and subscribe to our You Tube channel.