Profitable ETF trading strategies are a smart experiment with relative strength

Typically, traders will apply various technical analysis indicators to the instrument’s price behavior to find points of advantage. Many times they are combined in systems of increasing complexity and obvious sophistication. However, all of these concepts are based on direct price behavior. However, this is not the only way to use technical analysis.

Here is an example of using technical analysis in an unconventional way to quickly and consistently assess the relationship between a broad index and one of its major components.

Start by calculating the relative strength of the tool compared to its index. Perform this calculation by looking back. This makes sense depending on the timing you are going to keep the tool. As an example, you might assume that volatile stock trading with a large capitalization in the industrial Dow 30 gives the advantage to agile traders who cannot afford to observe the market during the day.

You might assume that Dow 30 Industrials is a smart set of ultra-large-cap stocks that are not likely to go bankrupt overnight and that are behaving conservatively compared to some small-cap stocks and foreign stocks based on rich analysis and broad ownership of institutional money. It is rare for these stocks to be wildly wrong, and their stock performance is characterized by relatively smooth price changes from day to day.

At any given time one or more of these stocks will exhibit leadership qualities in that they will outperform the broad index and its counterparts in one to four weeks. At the same time, there will be many of these stocks that are not working at the same time. There comes a point when individual leaders and laggards can no longer maintain their extreme behavior, and they begin to return to the average of the index itself.

By calculating the relative strength of each of the stocks on a daily basis and plotting that performance on a standardized scale from 0 to 100 for each stock, you can find times when extreme conditions begin to stabilize and cancel out.

In case of lagging behind it can warn you of the possibility of buying a price just as it starts to return to average. In the case of leaders, this can alert you to the possibility of ending a period of transformation.

By applying these relative strength curves to a technical indicator based on a channel such as Williams% R, you can view the upper 20 and lower 20 percentiles as regions of extreme behavior and thus prepare yourself for the reverse of the previous trend.

I have not yet subjected this idea to rigorous reverse testing, but the concept is intuitively appealing. This understanding is based on inductive reasoning based on many years of observation, and may be worth a closer look.