The RS line

After this lesson you can construct and read an RS line, and you'll know the early tell it gives that price alone can't.

One division, plotted

The RS line is the stock's price divided by the benchmark's price, plotted over time. That's the whole construction: stock at €84, index at 5,600, ratio 0.015, recomputed every day and drawn as a line. The absolute level of the ratio doesn't tell you anything, since it depends on two arbitrary price scales. The information is in its direction.

• RS line rising: the stock is outperforming the benchmark, whatever either is doing in absolute terms.
• RS line falling: underperforming, even if the stock's own price is rising.

The second of those deserves a worked example, because it's where the tool earns its keep. A stock grinds up 8% over three months, and the chart looks decent enough on its own. The index rose 20% over the same stretch. So the RS line fell the whole time, and the decent-looking chart belonged to a laggard being carried along by the tide.

One construction note that matters in practice. The ratio has to compare prices from the same moments, today's close over today's close. That sounds obvious, and sloppy tools violate it whenever one series has a holiday, a halt or a shorter history than the other. A ratio built from mismatched timestamps produces artificial kinks, and kinks read as signals. Worth checking your tool once, at the start.

The tell

Here is the reading the lineage prizes most, William O'Neil most explicitly: the RS line making new highs before the price does.

Picture a stock in a base (School III), price moving sideways between €44 and €50 for four months, going nowhere in particular. Meanwhile the market spends those months correcting. Sideways during a falling market is outperformance, so the RS line has been rising through the whole boring base, and if the relative performance is strong enough the RS line pushes to new highs while price still sits mid-base.

Read that with School I's eyes. Through a stretch when the market gave every holder a reason to sell, someone absorbed the selling in this stock and held its price flat. That's accumulation with a signature on it, weeks ahead of the breakout School V will teach you to trade. By the time price prints a new high, everyone can see the move. The RS line got there earlier, on a chart that still looked ordinary, and anyone who had plotted the ratio could see it.

The mirror reading matters too. A stock at new price highs whose RS line stalls or falls is being outrun by its benchmark. Late, tired advances often look exactly like that, and it's one of the character-change clues School V's selling course collects.

Check yourself

1. A stock falls 4% while the index falls 15%. What does the RS line do, and what might it mean? (It rises — relative strength during weakness. Someone is absorbing the selling; the classic accumulation footprint.)
2. Why is the RS line's absolute level meaningless? (It's an arbitrary ratio of two prices. Only its direction — the relative trend — carries information.)
3. State the tell, and why it leads. (RS new highs before price new highs. Outperformance through a correction shows accumulation before the breakout makes it public.)

The idea this lesson installs

Watch for the RS line to lead the price.

Next: Course 3 — "Leaders and laggards."