Relative Rotation Graphs, commonly referred to as RRGs, are a unique visualisation tool for relative strength analysis. Market participants can use RRGs to analyse the relative strength trends of several shares against a common benchmark, and against each other. This will also assist in finding pair or relative trading ideas.
The real power of this tool is its ability to plot relative performance on one graph and show true rotation.
We have all heard of sector and asset class rotation, but it is hard to visualise this “rotation” sequence on linear charts. RRGs use four quadrants to define the four phases of a relative trend. True rotations can be seen as shares moving from one quadrant to the other over time.
Herewith is a summary of an RRG model graph:
The arrows on the model graph above show the idealised rotation, which is clockwise. Let's assume a share is currently in the leading quadrant (green) and follow the idealised rotation. Remember, momentum is the leading indicator here and it will be the first to turn. From the leading quadrant, relative momentum will start to level off and momentum will move below 100, which will cause the share to move into the lower right-hand quadrant (weakening).
Extended weakness in relative momentum will ultimately affect the trend in relative performance and the ratio will also move below 100, which would put the share into the lagging quadrant (red).
Once in the lagging quadrant, the first sign of strength will be an improvement in relative momentum. When momentum crosses above 100, the share will move into the improving quadrant (blue).
A share in this quadrant still has a downtrend in relative performance, but momentum is improving and this could foreshadow a move into the leading quadrant (green). Extended strength in relative momentum will ultimately affect the trend in relative performance and the ratio will move above 100. This will push the share into the leading quadrant (green) and the cycle will start over again.
Interpretation
Before looking at some interpretation guidelines, bear in mind that RRGs are not a trading system and there are no predefined trading rules or signals. Look at RRGs as another type of charting method that is open to interpretation. Different people looking at the same chart will come up with different interpretations.
Here are some rules of thumb you may want to follow:
The rotational patterns are not always perfectly circular and will not always rotate through all four quadrants in a clockwise manner. These are, after all, financial markets driven by fear and greed.
The underlying trend-following model that powers RRG includes a lag period, as do all trend-following models. This means there will already be upward movement in the price relative before the RRG line actually crosses into the leading quadrant. Similarly, the price relative will peak and move lower before the RRG line actually crosses into the lagging quadrant.
Shares in the leading quadrant should be on your buy list because they show relative strength. Shares in the weakening quadrant should be on your watch list for deterioration (sell). Shares in the lagging quadrant should be on your avoid list because they show relative weakness. Shares in the improving quadrant should be on your shopping list as potential buys.
RRG on its own is not enough for making trading and investment decisions. Instead, RRG is great for channelling your attention to those areas of the market that deserve it.
Top 40 index RRG
The graph highlights the members of the Top 40 index against the Top 40 index (J200) as a benchmark. The look-back period is the last 5-days.
The graph is presented as a snap-shot chart and will be updated daily, using end-of-day data. The JSE shortcode of the shares is used.
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