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Faltering Relative Strength Is A Subtle, Valuable Sell Signal

The stock market isn't a business where you have a good idea and can keep it to yourself forever. The more people who know about a great stock, the more likely it is to do well.

It's also true that, while leading stocks are often unique, their strength also tends to reflect circumstances within their industry. Weak industries rarely produce strong stocks. Healthy industries often produce packs of strong stocks.

Applied to the study of sell signals, this fact can provide some corroborating affirmation of strength or a timely warning. In fact, a key sell sign occurs when the IBD Relative Price Strength (RS) Ratings begin to falter among a leader's industry peers.

First, let's talk about the RS Rating itself as a gauge.

The RS Rating compares a stock's performance over the past 12 months to all the stocks in IBD's database.

Top stocks generally hold RS Ratings of 90 or higher. They nearly always come from industry groups in which at least three or four other stocks hold similar RS Ratings, even if their earnings or other fundamental measures are not leadership grade.

A group's RS Rating is the primary gauge around which the IBD industry rankings are formed. So top ranking groups nearly always have at least a handful of stocks with strong RS Ratings.

Consider Rentech Nitrogen (RNF). As an IBD 50 stock in mid-December, it earned support from group mates such as Syngenta (SYT), with a 90 RS Rating and thinly traded American Vanguard (AVD), with a 92 RS. Agrium (AGU) scored an 81 rating.

Rentech remained on the IBD 50 list through mid-January. It broke out of a base at 40.59 on Jan. 7 and maintained an RS rating of 97. But the group, part of a laggard Agriculture sector that ranked just 22nd among 33 IBD sectors in the newspaper's research tables, failed to keep its decent RS ratings.

By Jan. 18, American Vanguard's RS had slipped to 90. No big deal. But Syngenta's RS dived to 85. Agrium cratered to 63. Investors watching the group's RS ratings would have been on alert when Rentech began to crumble in the first week of February.

On Feb. 22, when Rentech triggered the 8% loss rule, its RS Rating was an 89, and its Accumulation-Distribution Rating soured to an E. Shares lost 39% from Feb. 1 to April 17.

Weaker groups may also hold potential for new buys. Generac Holdings (GNRC), for example, is in the electrical power equipment group. The group ranked a weak No. 143 on Monday among the 197 industries tracked by IBD.

Generac, a maker of emergency and supplemental power generators, had a barely passable RS Rating of 80, but five stocks in the group hold RS Ratings above 90. The group's weak rank suggests a portion of the group's stocks might be breaking down. The high RS Ratings point to a group of stocks holding their ground.

Compare that to vitamin and nutritional supplement retailer GNC Holdings (GNC). Its RS is also a barely passable 78. Its specialty retailers group ranks No. 172. But not one stock in the group holds an RS rating of 90 or higher. The top RS rank, an 89, is held by thinly traded Luxottica Group (LUX).

It is not unusual for stocks that are thinly traded or have very weak fundamentals to boast high RS Ratings. So the highest RS Rating does not necessarily indicate the top stock in a group.