Today's Quote: “Crises and deadlocks when they occur have at least this advantage, that they force us to think." - Jawaharlal Nehru.

Yesterday we discussed relative strength and one of the biggest limitations in using this concept. Today let's take a look at one of the best uses of relative strength.

This concept, like most all concepts in trading, can be applied to any time frame you choose. For simplicity let's use a daily chart as an example. Let's compare to very similar setups in two very similar stocks. Lets say stock ABC and stock XYZ are both technology stocks that, generally speaking, follow the market. Lets say they both have similar chart patterns that have set up on the daily chart as pretty good-looking VCM buy set ups. They have both been in some kind of uptrend, and they both have a three to five bar pullback to some kind of support area and are showing signs of turning around in this area.

Now let's imagine that each of these set ups occurred at different times. Let’s say the ABC set up occurred while the market was pulling back from a recent new high in an uptrend. Let’s say the XYZ set up occurred after the market had put in five green bars on the daily chart. Which would be the butter play? Which would have the greater odds of success?

It should be fairly obvious to you the stock that is setting up as a VCM buy set up as the market is pulling back is going to be the superior set up to the one that formed while the market had been moving straight up. The relative strength is what makes the difference. If the market is moving up and the stock you wish to play is falling during the same days, you have to ask what is going to make the stock move up once the market decides to pullback, which it usually will after three to five day run.

When going back and reviewing charts you may get very involved studying every little detail of the pullback. You may look at the gaps that occurred, the size of the bars, and many of the details of the play to determine what will produce the best setup. However, all that is likely to fall to a distant second place if one of the set ups is showing extreme relative strength while the other one is showing extreme relative weakness. This concept applies to all time frames and all traders should incorporate the concept of relative strength in there trading plan.