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I think the shortcomings of the standard RS that this addresses are twofold:
- standard RS is not tradable - I can't trade one security divided by
another, but I can be long one and short the other - but that begs the
question, in what ratio? Hence the move to a volatility normalization
- standard RS doesn't take volatility differences into account. NDX RS vs
SPX looks a lot like NDX itself, as NDX has a Beta of around 1.6 - you're
still left with a lot of pure NDX movement
I think this does come into play if you are using relative strength as the
basis for sector switching - particularly if your position sizing is
volatility based.
Come to think of it, that may be the answer. If you use volatility based
position sizing, then you should use risk-adjusted RS. If you are using
constant dollar, then just use 1:1 (of course, the overall volatility of
your portfolio will be much higher..).
Worth exploring for a while, anyway.
Best
Andrew
-----Original Message-----
From: equismetastock@xxxxxxxxxxxxxxx [mailto:equismetastock@xxxxxxxxxxxxxxx]
On Behalf Of metastkuser
Sent: Tuesday, June 07, 2005 7:05 PM
To: equismetastock@xxxxxxxxxxxxxxx
Subject: [EquisMetaStock Group] Re: Volatility adjusted relative strength
Andrew,
Interesting thought. I'm doing quite a bit right now with volatility
-- for setup, entry, exit and money management -- and had not thought of
this.
The result of normalizing the RS using beta or atr would suggest a "risk
adjusted" metric for comparing one security's RS against another's.
I'm not sure if that is worthwhile. I like to know the "raw" RS first. Then
I do my "risk adjustments" (i.e. volatility-based position sizing and money
management stop placement) as a next step. Merging these two steps might
fail to highlight some high RS/high volatiltiy (but
promising) candidates?
--- In equismetastock@xxxxxxxxxxxxxxx, "Andrew Tomlinson"
<andrew_tomlinson@xxxx> wrote:
>
> I've been playing around with calculating relative strength not as
C/index
> but as a volatility adjusted spread. This more nearly approximates the
> relative performance assuming an equal amount of risk-adjusted capital
> invested in each security. So, for example, rather than a regular
relative
> strength vs. the S&P500
>
> SP:=Security("C:\MetaStock Data\Indeces\.spx",C); RS:=C/SP;rs;
>
> I would take the spread between the two securities adjusted for their
> volatility expressed as ATR as % of price e.g.
>
> P1:=50;
> S1H:=H;
> S1L:=L;
> S1C:=C;
> S2H:=Security("C:\MetaStock Data\Indeces\.spx",H);
> S2L:=Security("C:\MetaStock Data\Indeces\.spx",L);
> S2C:=Security("C:\MetaStock Data\Indeces\.spx",C);
> TR1:=Max(Max(S1H-S1L,S1H-Ref(S1C,-1)),(Ref(S1C,-1)-S1L));
> ATR1:=Mov(TR1,P1,S)/Mov(S1C,P1,S);
> TR2:=Max(Max(S2H-S2L,S2H-Ref(S2C,-1)),(Ref(S2C,-1)-S2L));
> ATR2:=Mov(TR2,P1,S)/Mov(S2c,P1,S);
> Ratio:=ATR1/ATR2;
> Spread:=S1C-S2C*ratio;spread;
>
> I'm curious - has anyone else looked at this? Theoretically, this
would be
> an alternative to any regular relative strength calculation, and would
> better reflect the reality of "am I better off investing in A or
B?". I have
> also seen this done using beta as the volatility measure.
>
> Andrew
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