- : January 25, 2021
- : Prashant Shah
When there is a breakout in price chart –> it would mean price can go up.
When there is a breakout in ratio chart –> it would mean numerator can outperform denominator.
So, Ratio chart can also be a part of our trading system. Let’s decide a very simple rule –
when we buy, price and Ratio chart both should be bullish.
What does it mean?
Breakout in price chart = Price can go up.
Breakout in RS chart = It is a potential outperformer.
Why is outperformance important?
Hum Saath Saath Hain!
When we divide a price of one instrument with another we get a ratio of two instruments. When this ratio is plotted on a daily basis we get a ratio chart. Below is a Ratio chart of Bank Nifty v/s Nifty. Numerator is Bank Nifty and denominator is Nifty in below chart.
When ratio line is rising, it means numerator is outperforming denominator and when ratio line is falling, it means numerator is underperforming denominator.
For more clarity, you can refer to videos on Ratio chart in RS segment of Insight. So, we can analyse ratio chart the way we analyse price chart.
But you must know that:
It means that the stock is relatively strong. It can do better than others if market or denominator goes up. If denominator wouldn’t perform as per expectations – stock would probably fall less, or it may still go up.
Price chart bullish + RS chart bullish = Long Price chart bearish = Exit Long
Price chart bearish + RS chart bearish = Short Price chart bullish = Exit Short
RS chart is not considered for exit, because we can know price stop in advance ratio chart
stop is difficult to know in advance. Let’s keep it simple.
What should be a Denominator in RS chart?
Numerator is a stock that we want to analyse. But what should be a denominator: Nifty 50, Nifty 500 or Sector?
Top-down approach and RS analysis = Sector compared to Nifty -> Stocks compared to Sector and Stock compared to Nifty.
But we will come to this later. Let’s start from basic.
To simplify, let’s keep denominator as Nifty 50 – a major barometer for Indian stock market.
Nifty 500 can also be opted but result wouldn’t differ much.
How do we define price and RS charts as bullish or bearish?
So, Price and RS system should be:
Think – Have you developed any method to find breakout on price chart? Are you trading any system on price chart? If yes, same can be developed on Ratio chart. You have a system on both the charts.
Bullish trade = Price is above 20-day Moving average on daily, weekly and monthly chart. Bearish trade = Price is below 20-day Moving average on daily, weekly and monthly chart.
Above chart is bearish on all three time-frames. This is a kind of multi-timeframe breakout system.
Same rules can be applied on Ratio charts as well.
Bullish trade confirmation = Ratio of stock v/s Nifty is above 20-day average on daily, weekly and monthly chart.
Bearish trade confirmation = Ratio of stock v/s Nifty is below 20-day average on daily, weekly and monthly chart.
Ratio in above chart is below its 20-SMA in all three timeframes. That means, price and RS are bearish on multiple-timeframes.
How to scan above system in TradePoint?
Let’s create a system first on a price and Ratio chart:
- Go to TradePoint -> BackTesting -> System Builder.
- Select OHLC chart.
- Add -> Indicators -> Single Moving average -> Price above 20 SMA -> Click on Ok.
- Put Expression as 1 and give a name to the system as ‘Price above 20 SMA’. Check
- Click on Ok.
- Select Ratio chart in same System builder.
- Add -> Indicators -> Single Moving average -> Price above 20 SMA
- Put Expression as 1 and give a name to the system as ‘Ratio above 20 SMA’ and save.
- Go to Matrix -> OHLC System Matrix.
- Select Stock Group. Eg: F&O Stocks.
- Select Daily, Weekly and Monthly timeframe as shown in the image below.
- Select System as Price above 20 SMA on each timeframe and scan.
You will see score of all stocks on each timeframe and the total score. Score 1 = Price is above 20 SMA on that timeframe, rule is qualified. Score 0 = Not qualified.
So, when score is 3 – that means price is above 20-SMA on all three timeframes.
- Put 3 in Score Value and Save those stocks in a Group as shown in below image.
- Give name to the group : HSSH.
- Go to Matrix -> Ratio System Matrix
Stocks with score 3 are above 20-day ratio on Daily, Weekly and Monthly chart.
So, now you have a list of bullish stocks in price and RS on daily, weekly and monthly timeframes
It is only for example. It could be any other parameter or any other system. For example, RSI above 60, ADX crossover or any other indicator for that matter. System can be different on price and Ratio charts as well. But let’s go step by step.
P&F Relative Strength
Ratio line chart can be converted into P&F chart as well. It is known as P&F Relative Strength
chart. Let’s talk about a simple single timeframe system on same lines on a P&F chart.
A system on P&F chart:
Definition of bullish price chart or RS chart = Double-top buy. Definition of bearish price chart or RS chart = Double-bottom sell.
- Select Stock Group: HSSH
- Select Daily, Weekly and Monthly timeframe as shown in the image below.
- Select System as Ratio above 20 SMA on each timeframe and scan.
So trading rules on P&F charts are as follows:
Double-top buy in Price chart & Double-top buy in RS chart = Long Double-bottom sell in price chart = Exit Long
Double-bottom sell in price chart & Double-bottom sell in RS chart = Short Double-top buy in price chart = Exit Short
This is simple to scan in TradePoint. You can run a query for double top buy signal in price and RS scanners.
Read the system rules again. Now, read below statements:
Bullish price chart and bullish RS chart is bullish. What if,
Price chart is bullish but RS chart is not bullish (Not outperforming)? We have to wait for RS chart to turn bullish. Difficult to know that in advance.
RS chart is bullish (Outperforming) but price is not bullish? We can buy if there is a price breakout. Price breakout level can be known in advance!
Process to select stocks based on a breakout in price and RS charts:
- Go to TradePoint -> Scanner -> P&F RS Scanner
- Select Denominator as Nifty 50
- Scanner type as Double Top Buy Signal
- Select stock group – For example, F&O stocks
- Scan and Save the result in a Group. Let’s give it a name ‘HSSH: 17-05-2020’.
Not Double-top buy is a pattern where breakout is yet to be triggered.
With this, you get a list of stocks which are bullish on RS chart and not bullish on price chart. They are outperforming the Nifty.
- Go to Scanner -> P&F scanner:
- Select Group: HSSH 17-05-2020
- Run a scanner for Not Double top buy
You have an opportunity if double-top buy gets triggered.
Can we add moving average to above rules?
Yes. Even Multi-timeframe in this is possible. But let’s go slow. This is just a beginning that gives you a rule that we will trade when price and RS are in sync. Jab dono sath sath hai.
RS chart turning even to column of X is bullish. We will talk about RS reversals and more ways of trading price and RS charts. Nonetheless, the system that we have discussed above is simple, yet effective.
- Check the double-top buy level on price chart.
- Analyse the chart.
- Assess the risk.
We discussed BOOST and Matrix – Uchchalan, Pachhadat systems in our recent newsletters : how about trading them only when there is a double-top buy breakout in RS chart? – Explore
System examples discussed above are for bullish trades. Exactly opposite rules can applied for bearish trades.