Which Investment Is Stronger?

How strong are your investments? Strength is relative.

One way of comparing the performance of one stock to another is by charting relative strength. The relative strength is calculated by comparing the value of one stock (or index), over time, to the value of another.

Photo courtesy of koka_sexton, courtesy of flickr

To start tracking relative strength, the stocks do not have to start with the same price, but the initial investment in each must be the same amount.

So, let’s suppose we start out with $250 and want to see which stock was stronger, Jet Blue (Ticker: JBLU) or United Airlines (Ticker: UAUA).

At the start of the year, with a $250 investment we would have been able to purchase 35.21 shares of JBLU ($7.10/share) or 22.69 shares of UAUA ($11.02/share).

The chart starts with a relative strength of 1.00, since both investments are worth $250. As prices change, the relative strength will reveal which investment is stronger by dividing the total value of our shares of JBLU by the value of our shares in UAUA.

Here are the monthly closing prices for JBLU and UAUA, from January to March.

JBLU: $5.63, $3.81, $3.65 and UAUA: $9.44, $4.91, $4.48

So at the end of January, JBLU shares are worth $198.23 (35.21 shares @ $5.63/share) and UAUA shares are worth $214.19 (22.69 shares @ $9.44/share). The relative strength is $198.23/$214.19 = 0.925. So, at the end of January, our investment in JBLU is worth 92.5 percent of our investment in UAUA.

Since we divide JBLU by UAUA, if the relative strength is less than 1.0, then JBLU has underperformed UAUA. If the relative strength is greater than 1.0, then JBLU has outperformed UAUA.

One flaw of the relative strength is that it doesn’t tell us that both of these investments lost money, but it does tell us which one lost more or less.

In this example, the relative strength was used to plot one company against another, but it can also be used to compare one stock to an industry or an index.