Relative Strength Matrix Basics

What is the Matrix?

In the simplest terms, the Matrix is the tool we use to develop a Relative Strength ranking for a universe of securities. 

Matrices can be used to analyze the Relative Strength picture among any type of security in the NDW database- stocks, ETFs, mutual funds, indices, models, etc. 

The idea behind the Matrix is simple- If I know I want to invest in a certain number of securities from a particular universe, I want to compare each of the securities in that universe on a Relative Strength basis to determine which securities are the true market leaders. 

How is a Matrix created?

A Matrix is created by running individual Relative Strength comparisons for each security in the universe against each of the other members of the universe. The example below has 7 securities in the universe, so each security will undergo 6 Relative Strength comparisons. (it cannot be compared to itself) The white line diagonally across the middle of the Matrix shows where each security intersects with itself. 

Each box in the Matrix, therefore, corresponds to an individual Point & Figure Relative Strength chart with the security on the left as the numerator and the security on the top as the denominator. The box highlighted below shows the Relative Strength relationship between QQQ and EEM. BX means that QQQ is currently on a buy signal and in a column of Xs on its Relative Strength chart vs. EEM, which means QQQ is stronger than EEM on a long-term and intermediate-term basis. 

There are 4 possible states for a Relative Strength chart shown within the Matrix. They are listed below in descending order of strength. 

1. BX- the security on the left is on a buy signal and in a column of Xs on its Relative Strength chart vs. the security on top. In other words, the security on the left is stronger than the security on top on both a long-term and intermediate-term basis. 
2. BO- the security on the left is on a buy signal and in a column of Os on its Relative Strength chart vs. the security on top. In other words, the security on the left is stronger than the security on top on a long-term basis but the security on top is stronger over the intermediate term. 
3. SX- the security on the left is on a sell signal and in a column of Xs on its Relative Strength chart vs. the security on top. In other words, the security on the left is weaker than the security on top on a long-term basis but stronger than the security on top over the intermediate term. 
4. SO- the security on the left is on a sell signal and in a column of Os on its Relative Strength chart vs. the security on top. In other words, the security on the left is weaker than the security on top on both a long-term and intermediate-term basis. 

Matrix rankings are then determined by the total number of buy signals a security has vs. each of the other securities in the universe. In the below Matrix, you'll notice QQQ is ranked #1 because it is considered a buy 6 out of 6 times. 

The number of X columns is used as a tiebreaker if the buy signal value is equal. As you can see above, SPY and EFA both have 3 buy signals, but SPY is ranked ahead of EFA because it has 5 X columns to EFA's 4. 

Help me understand this

Think about the Matrix like a round robin tournament where a team plays each of the other teams head-to-head to determine who moves on. Whichever team wins the most individual games is deemed to be the strongest. 

The idea with the Matrix is the same- we match up each security head-to-head and the securities with the most "wins" (buy signals) are considered the strongest.

While there is always the chance that a weaker team pulls off a few upsets and ends up at the top of the rankings even though they aren't as strong as they may appear to be, the majority of the time, the truly strong teams will rise to the top. And fortunately, unlike the World Cup, the investment process is ongoing, allowing us to adjust as new leadership emerges.

How do I use the Matrix?

There are many ways to incorporate the Matrix into your investment process, but let's focus on 3 broad use cases- asset allocation decisions, sector rotation, and security selection.

No matter how you intend to use the Matrix, our research has shown it is most important to focus on investing in securities at the top of the Matrix. There is a common desire to try to catch securities "on the way up," but it is very difficult to discern between those that are on the way up, those that are on the way down, and those that are simply middling. 

Asset Allocation

Using broad market ETFs, mutual funds, or indices you can use the Matrix to develop a sense of where to overweight your portfolio to concentrate its allocation in areas of strength. For example, you can use our premade Asset Class Matrix to compare broad market ETFs. From there you can either invest directly in those ETFs at the top of the Matrix for broad exposure to the asset class or use the rankings as a guideline to dive deeper into the asset classes near the top for specific security ideas. 

Sector Rotation

Using sector-focused ETFs, mutual funds, or indices you can use the Matrix to keep your portfolios allocated to the strongest sectors at all times. For example, you can use our premade Sector ETF Matrix to view a Relative Strength ranking of iShares and SPDR sector ETFs to determine which sectors to allocate assets towards. Similar to the asset class approach discussed above, you can either invest directly in those ETFs or use the rankings as a guideline before digging further into the sector for specific investment ideas. 

Security Selection

The Matrix can also help you determine specific securities to buy based on Relative Strength. For example, the above Sector ETF Matrix shows Technology in the top 2 spots in the Matrix. You can then use the Technology ETF Matrix to find specific Tech ETFs to invest in. 

If you would prefer to look for individual stock ideas, you could also use something like the Semiconductor Matrix to drill down further into technology to find what you are looking for.