"Relative Strength as a Criterion for Investment Selection, Journal of Finance"
This
study examined the relative strength as a criterion for investment selection.
Many authors in time past has conducted research on past price trend and
patterns in predicting future price movement and come out with the report that
successive stock market price changes are statistically independent upholding
the random walk theory. It is in line with the above that this study sought to;
(i) evaluate the relationship between cost of a given security and proceeds
which would have been received upon sale of the security, (ii) evaluate the
concept of relative strength co-movement of stock price, (iii) evaluate the
extent which historical market rank could be used to facilitate market timing.
METHODOLOGY
The
researcher adopted the ex-post facto research design and analysed the reported
observation of the study variables extracted from the weekly closing prices on
listed stock on the New York Stock Exchange. The scope of the study is on two
hundred (200) listed stock and the period covered is two hundred and sixty
(260) week period beginning of Oct 1960 and ends Oct 1965. Parametric statistic
in form of simple linear regression, coefficient of correlation, moving average
and hindsight were used for data analyses.
RESULTS
The
key findings derived from this study include the following; The result of the
correlation shows that intercorrelation or co movement of stock prices could
conceal existing dependency in successive prices. That market ranks would
probably be about the same no matter whether hindsight were used or whether
sometime period prior to the period of this study were adopted as a standard of
dispersion six month marketing performance. Average ranks are not affected by
extreme price movement of one or more securities, but this is not true of
average ratio. Average ranks and ratio support the concept of continuation of
relative strength. The stock which historically were among the 10% strongest
(lowest ranked) appreciated in price by an average of 9.6% over a 26 week
future period while the stock among the 10% weakest ( highest ranked)
appreciated in price an average of only 2.9% over a 26 week future period.
There appear to be a good correlation between past and future performance
grouping. The conclusion is that the relative strength tend to continue over the
longer 26 period but does not appear to be the case fpr the 4 week period. The apparent
unpredictability of the short term result collaborate the result of serial
correlation studies which show short term price movement to be random. The
average price appreciation of the historical strongest securities shows the non-randomness
in price changes. In Table 2 the (historical strongest) volatile stock group
shows a wider dispersion of average 26/c rank, 26/c average ratio. The
continuation of relative strength seem to be applicable to the market as a
whole as well as individual securities. While table 4 and 5 indicate that the
greatest 26 week rates of return are attain when selecting the 10%
historical strongest stock and the third
divergence rank group: and the poorest return arise from selecting those stocks
in the first divergence rank group. This means that stock on first divergence
rank group do not appear to adhere very closely to the continuation of relative
strength. Securities in the middle and third group are quite consistent in
following the patterns forecasted by their relative strength ranks. The result
implies that long term strong divergence ranks might be an effective means of
forecasting long term market weakness. The validity of using market rank or
divergence ranks to facilitate market timing must be of tentative nature.
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