Fool.com: Mechanical Modeling Continued (Workshop) August 6, 1998

Mechanical Modeling Continued

ALEXANDRIA, VA. (August 6, 1998) -- Last night, we took a look at relative strength and what sorts of stock screens we can come up with using this tool. What I failed to do was explain what relative strength is and why it's even looked at by investors. For the sake of this discussion, relative strength refers to a stock's price and how strong the stock's price performance has been relative to all other stocks out there.

Investor's Business Daily uses a 12-month period to measure relative strength. The absolute best performing stocks over any 12-month period get the highest ranking of 99. There are two general schools of thought with regard to relative strength. On the one hand, proponents of the metric say that investors should want to buy the strongest stocks in the market and that one way to measure strength is by looking at price performance. Others argue that looking at price performance is the best way to get crushed as those stocks that have achieved the highest rankings have only one place to go... down.

In yesterday's column, I spotlighted a group of stocks that I uncovered in late 1996. Each of the stocks, at the time, had an RS (relative strength) ranking of 99. They all were within 10% of their 52-week high, and all of them were over $5. I did this to see how such a seemingly impressive group of stocks might perform over the longer haul.

Can you say "Train Wreck!!?"

It was just horrible. Look at yesterday's report for the gruesome details. Most stocks did horribly and even those that did okay were still well below the market's performance. At the end of the column I started to question whether or not this list might be better used to screen for short sales than it would for long purchases. I still have no real feeling on the matter, but today I offer you the latest crop (fresh out of today's IBD) of stocks with 99 RS, within 10% of their highs, and above $5.

 
 Best Buy <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BBY)") else Response.Write("(NYSE: BBY)") end if %>            $50.25 
 Dekalb Genetics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DKB)") else Response.Write("(NYSE: DKB)") end if %>     $90.75 
 Evans Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: EVSI)") else Response.Write("(Nasdaq: EVSI)") end if %>    $5.25 
 Netcom Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NETC)") else Response.Write("(Nasdaq: NETC)") end if %>   $45.50 
 Orange PLC <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ORNGY)") else Response.Write("(Nasdaq: ORNGY)") end if %>      $58.50 
 Republic Eng. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: REPS)") else Response.Write("(Nasdaq: REPS)") end if %>    $6.75

Oddly enough, none of the "red-hot" Internet stocks made this list because none of them are within 10% of their highs, though many had 99 RS rankings. So, I pose the question tonight that I posed last night: is this a great short-sale list? I suppose only time will tell. Sometime in 1999, I'll revisit this little number and report back. I'll leave you tonight with the words of one of our web board participants, Mikeraz.

"I've always viewed RS as a short term indicator. That high RS stocks from 2 years ago have now dropped down the tubes doesn't surprise me. In O'Shaughnessy's book (What Works...) the RS screen didn't work too well. But his screen was for the previous year and his time to hold the stock was one year also."

Does this mean that RS is only good for short-term trading? More questions than answers, now. Let's work together to figure this all out.

Take care,
David

[Robert Sheard is on vacation this week. He will return on August 10.]

Check out the latest file updates for the Workshop:
New Rankings | 1998 Returns | New Database

[Robert Sheard is the author of the The Unemotional Investor (Simon & Schuster, 1998) available now at Amazon.com and your local bookseller.]