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Relative Strength Rating Pinpoints A Stock's Power

Everything in the stock market is relative. You want to buy stocks that are, relatively speaking, better than others.

You want strong gains relative to the market. You'd like to be able to achieve all of this with relative ease.

Two helpful tools on all three counts are IBD's Relative Price Strength Rating and the Relative Strength line.

The RS Rating gauges a stock's performance vs. all other stocks in IBD's database over the past 12 months. Stocks like Mellanox Technologies (MLNX), with a 99 rating, have outperformed 99% of all stocks tracked by IBD over the past 12 months.

IBD Chairman and founder William O'Neil says RS Ratings are similar to fastballs thrown by the best pitchers.

"The average big league fastball is clocked at 86 miles per hour," O'Neil wrote in "How to Make Money in Stocks." "The best pitchers throw 'heat' in the 90s.

An RS rating of 90 or better means a stock is already outperforming 90% or more of the market — even before possibly breaking out and starting its run.

But like any other measure, a high RS Rating doesn't guarantee a winning run; it alone is not a buy signal, but simply one element helping you increase the odds of making money.

A stock that has sprinted straight up for weeks or months is likely to hold a high RS rank. But it will often be extended, with no real buy point in sight. The trick is to find a stock that has managed to build or maintain a high RS Rating while basing.

The Relative Strength line gauges a stock's performance vs. the S&P 500 index. A rising line means the stock is outperforming the broader market. That's good.

What you ultimately want to see is a stock near a buy point, showing a high RS Rating (say, 90 or better) with an RS line that in most cases is near or breaking to new highs. IBD research shows, from 1950 through 2008, the average RS Rating of the best-performing stocks just prior to their winning runs was 87.

You can find RS Ratings in numerous places in IBD and at Investors.com. In an IBD chart, the RS line is painted blue and usually found under the price bars.

Take a look at the charts for Mellanox. It had the combination of a top-shelf RS Rating and an RS line moving to new highs just before it broke out June 11.

Or compare Apple (AAPL) and Priceline.com (PCLN) — both climbing the right side of three-month bases. Apple's RS Rating is a 93, down from 96 five weeks ago. Its RS line has inched up and is leaning toward a new high.

Priceline's RS Rating has held steady near 88 for the past five weeks. Its RS line has ebbed, however, and is well below its April high. Keep an eye on the RS line as leading stocks climb the right side of their respective bases.