Tips on Technicals - Relative Ratio
Indicator type: |
Relative Strength/Performance Indicator |
Used to: |
Analyze the relationship between two instruments |
Markets: |
All cash and futures, not options |
Works Best: |
All markets and time frames although daily is most common |
Formula: |
Relative Ratio = A/B * 100 A1 / B1
Where A1 / B1 is the value of the ratio for the first period of the span. |
Parameters: |
There are no standard parameters although ratios are usually not weighted. |
Theory: |
Relative ratio charts are identical to "normal" ratio charts except for their vertical axis scaling. The first period of the span is set to a value of 100 and each subsequent value of the ratio is divided by the value of the first period. The scale then shows how the first item is performing compared to the second in percentage terms. |
Interpretation: |
The most important aspect of these charts is that they are span dependent. Different spans will yield different values although the shape of the plot is identical to a "normal" ratio chart.
With 100 as the starting value on the graph, subsequent values indicate whether the price ratio is improving or worsening, and by how much. Values greater than 100 indicate improvement -- a value of 115 would mean that the price ratio is up 15% (outperforming). Values less than 100 indicate worsening -- a value of 85 means that the price ratio is down 15% (underperforming).
Relative ratios can also be used as a presentation tool. A non-trading audience will easily understand that one item has outperformed the other by 15% over the past few weeks. Portfolio managers can plot their equity against a relevant market index to report their performance to shareholders over any time frame.
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This relative ratio chart reports that COMEX Gold is outperforming NYMEX Crude Oil by 2% for the year through 18 July. A spread position (unweighted for illustration purposes) would have been down over 11% by mid-May but rallied for a profit of 2% by July.