Defining Relative Strength and Weakness
Posted by Pete Stolcers on February 14, 2011
Option Trading Question
Can you please explain what relative strength and weakness mean as they pertain to options trading?
Option Trading Answer
In options trading, it’s vital to understand the terms you’re working with. Take the time to learn the vocabulary and what each strategy entails and you’ll be far more successful in option trading.
Regardless of what the market is doing, a stock with relative strength will most likely move higher. Stocks with relative strength are commonly characterized as being the first stock to rally if the market stops going down. It will also be down 1% on a big market slide. A stock with relative weakness will not have a bid no matter how much the market rallies and will fold at the first sign of trouble. Obviously, this is not what you want if you are aiming for strong stocks in your options trading.
To begin your option trading process review a 1-week chart of the option of your choice. In a bullish situation take particular note of price action a stock showed on a weak market day. If there was little change; that indicates that the bid was strong. This information also signifies that natural sellers were immediately met with buyers. This type of situation does not happen often, but always be aware if you see it.
Next, review a 1 month chart, to see if the same pattern can be detected from the 1 week chart. If the answer is yes, take a look at a 1 year chart. As you compare charts, always go with the strongest and best of breed stock. Beware of stocks that have moved considerably higher and fall if the market suddenly becomes volatile. It is normal for strong stocks to require a day or two of rest after a big move. Be sure to note if they are getting too far ahead of themselves. A bullish stock is an example of relative strength. After reviewing a 5 day chart, you will see a grind higher. This stock was chosen based on the fact that it had taken on a parabolic look when you review a 1 year chart. The second reason the stock was picked was for a comparison on how strong it had been during a recent 2 month market sell off.
It’s important to understand everything that can affect your options trading. Relative weakness and strength are two major factors that come into play when you are planning your option trading strategies, so be sure that you know how to read them.