Relative Rotation Graph

Technical Practitioners Corner
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Relative Rotation Graph

Relative Rotation Graphs are a visual tool used to analyze the relative strength and momentum of multiple securities against a common benchmark and each other. Developed by Julius de Kempenaer, RRGs simplify the comparison process by displaying all securities on a single chart, highlighting their performance trends over time.

RRG charts differ from other financial charts in that the horizontal axis does not represent time. The basis for an RRG chart is a scatter plot, with de Kempenaer’s Relative Strength Ratio indicator as the horizontal axis and his Relative Strength Momentum indicator as the vertical axis.

The Challenge of Traditional Relative Strength Analysis

Standard relative strength charts typically compare one security against a benchmark, resulting in multiple one-on-one comparisons when analyzing several securities. This approach can lead to information overload and makes it difficult to see the bigger picture.

For example, if you’re comparing the performance of various sectors against the S&P 500, traditional charts might not effectively showcase which sectors are improving or weakening relative to the benchmark and each other.

How RRGs Address the Challenge

RRGs plot multiple securities on a two-dimensional graph, divided into four distinct quadrants:

  1. Leading Quadrant (Top-Right): Securities here exhibit strong relative strength and positive momentum against the benchmark. They are in a relative uptrend and are expected to outperform.
  2. Weakening Quadrant (Top-Left): Securities have strong relative strength but negative momentum. They may start to underperform as their momentum wanes.
  3. Lagging Quadrant (Bottom-Left): Securities show weak relative strength and negative momentum. They are in a relative downtrend and are likely to underperform.
  4. Improving Quadrant (Bottom-Right): Securities have weak relative strength but positive momentum. They might be in the early stages of an uptrend and could soon outperform.

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The unique feature of an RRG is that each symbol is plotted as a dot with a “tail” extending backward. The tail shows you the history of the symbol’s position in the past. You can use a slider to control the length of the tail and dynamically scroll through history.

Each dot on each symbol’s tail represents one period - anywhere from 1 month to 5 minutes, depending on the “Period” setting. The large dot at the end of the tail represents the current RRG values for that ticker symbol. Those values are updated continually throughout the current trading week; however, new dots are only added at the start of a new week.

  • Leading (Green). Strong relative strength and strong momentum

  • Weakening (Yellow). Strong relative strength but weakening momentum

  • Lagging (Red). Weak relative strength and weak momentum

  • Improving (Blue). Weak relative strength but improving momentum

As you can see in the example above, stocks typically progress through the quadrants clockwise. The color of each line is determined by the color of the quadrant where the line ends. The width of each stock’s line is determined by the ending dot’s distance from the center of the plot.

Interpreting the Rotational Movement

The movement of securities on an RRG is typically clockwise, reflecting the natural rotation between the quadrants:

  • From Leading to Weakening: A security may start losing momentum but still maintains strong relative strength.
  • From Weakening to Lagging: Continued loss of momentum leads to weaker relative strength.
  • From Lagging to Improving: Momentum picks up, but relative strength is still weak.
  • From Improving to Leading: Both momentum and relative strength are strong, indicating a potential outperformer.

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Using RRGs for Investment Decisions

RRGs can help investors:

  • Identify Trends: Spot which sectors or stocks are gaining or losing strength relative to the benchmark.
  • Make Allocation Decisions: Allocate resources to securities in the Leading quadrant and consider reducing exposure to those in the Lagging quadrant.
  • Time Entries and Exits: Use the rotational patterns to determine optimal entry and exit points based on momentum shifts.

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Interpreting RRGs with Indian Market Examples

Let’s consider the major sectors within the Nifty 50:

  • Nifty Bank Index (Banking Sector)
  • Nifty IT Index (Information Technology Sector)
  • Nifty FMCG Index (Fast-Moving Consumer Goods Sector)
  • Nifty Pharma Index (Pharmaceutical Sector)
  • Nifty Auto Index (Automobile Sector)

By plotting these indices on an RRG against the Nifty 50 benchmark, investors can visualize how each sector is performing relative to the market and each other.

Thought for 6 seconds

An Introduction to Relative Rotation Graphs (RRGs) in the Context of the Indian Stock Market

Investing in the stock market requires analyzing various sectors and stocks to identify where opportunities lie. Traditional methods of comparing individual securities can be cumbersome and may not provide a holistic view of the market dynamics. Relative Rotation Graphs (RRGs) offer a solution by visually representing the relative performance of multiple securities against a common benchmark and each other. This article introduces RRGs with a focus on the Indian stock market.

What Are Relative Rotation Graphs?

Relative Rotation Graphs are innovative tools that plot multiple securities on a single chart, showcasing their relative strength and momentum over time. Developed by Julius de Kempenaer, RRGs help investors identify the rotation of money between different sectors or stocks, making it easier to spot emerging trends.

Challenges with Traditional Relative Strength Analysis

In the Indian stock market, investors often compare the performance of various sectors like IT, Banking, FMCG, and Pharma against benchmarks like the Nifty 50 or the BSE Sensex. Traditional charts require multiple one-on-one comparisons, which can be time-consuming and may not reveal the broader market movements.

For example, comparing the Nifty IT index with the Nifty FMCG index individually against the Nifty 50 might show their performance relative to the benchmark but won’t highlight how they perform against each other.

How RRGs Simplify Analysis

RRGs address this challenge by plotting all selected sectors or stocks on a single graph divided into four quadrants:

  1. Leading Quadrant (Top-Right): Securities here have strong relative strength and positive momentum against the benchmark, indicating they are outperforming the market.
  2. Weakening Quadrant (Top-Left): These securities still show strong relative strength but are losing momentum, suggesting a potential slowdown in performance.
  3. Lagging Quadrant (Bottom-Left): Securities in this quadrant have weak relative strength and negative momentum, indicating underperformance.
  4. Improving Quadrant (Bottom-Right): These securities exhibit weak relative strength but positive momentum, signaling potential future outperformance.

Interpreting RRGs with Indian Market Examples

Let’s consider the major sectors within the Nifty 50:

  • Nifty Bank Index (Banking Sector)
  • Nifty IT Index (Information Technology Sector)
  • Nifty FMCG Index (Fast-Moving Consumer Goods Sector)
  • Nifty Pharma Index (Pharmaceutical Sector)
  • Nifty Auto Index (Automobile Sector)

By plotting these indices on an RRG against the Nifty 50 benchmark, investors can visualize how each sector is performing relative to the market and each other.

Example Scenario:

  • Leading Quadrant:
    • Nifty IT Index: The IT sector, driven by companies like TCS and Infosys, is outperforming the Nifty 50 with strong momentum due to increased global demand for IT services.
  • Weakening Quadrant:
    • Nifty FMCG Index: FMCG companies like Hindustan Unilever may still show strong relative strength but are losing momentum due to rising input costs.
  • Lagging Quadrant:
    • Nifty Auto Index: The auto sector might be underperforming due to supply chain disruptions and decreased consumer demand.
  • Improving Quadrant:
    • Nifty Pharma Index: Pharmaceutical companies could be gaining momentum due to increased healthcare spending but haven’t yet started outperforming the benchmark.

Using RRGs for Investment Decisions

1. Identifying Sector Rotation

RRGs help investors identify sector rotation in the Indian market. For instance, if the Nifty Pharma Index moves from the Improving to the Leading quadrant, it may signal a good time to invest in pharmaceutical stocks.

2. Stock Selection within Sectors

Within a promising sector, RRGs can also be used to compare individual stocks. For example, within the Nifty IT Index, you can plot stocks like TCS, Infosys, Wipro, and HCL Technologies to see which ones are leading.

3. Timing Entries and Exits

  • Entry Point: Consider investing when a sector or stock moves from the Improving to the Leading quadrant.
  • Exit Point: Consider reducing exposure when a sector or stock moves from the Leading to the Weakening quadrant.

Practical Application Steps

Step 1: Select Your Universe

Choose the sectors or stocks you want to analyze. For the Indian market, this could be the major sectoral indices or top stocks within those sectors.

Step 2: Choose a Benchmark

Common benchmarks are the Nifty 50 or BSE Sensex. The choice depends on the composition of your selected securities.

Step 3: Plot the RRG

Use financial platforms or software that support RRGs. Input your selected securities and benchmark to generate the graph.

Step 4: Analyze the Quadrants

  • Leading: Consider increasing exposure.
  • Weakening: Monitor closely for signs of further decline.
  • Lagging: Avoid or reduce exposure.
  • Improving: Watch for potential investment opportunities.

Step 5: Monitor Regularly

Market dynamics change, so it’s essential to update your RRG periodically (e.g., weekly or monthly) to stay informed.

Considerations and Limitations

  • Supplementary Tool: RRGs should be used in conjunction with other analysis methods, such as fundamental analysis and other technical indicators.
  • Market Conditions: External factors like economic policies, global events, and currency fluctuations can impact performance.
  • Data Availability: Ensure you’re using up-to-date and accurate data for reliable analysis.

References:

Julius de Kempenaer Articles:
https://stockcharts.com/articles/rrg/

Videos:

Why the Stock Market is SO Confusing Right Now

Julius de Kempenaer Discusses RRG Charts

RRG: Navigating Strength and Momentum

Relative Rotation Graph LIVE Webinar Part 2: How to Use RRG in India Stock Market

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RRG

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  • Leading Quadrant (Green):
    • Indices such as Nifty Realty, Nifty Metal, and Nifty Private Bank are in the leading quadrant, indicating they are outperforming the benchmark and have strong momentum.
  • Improving Quadrant (Purple):
    • Nifty Energy, Nifty CPSE, Nifty PSE, and Nifty PSU Bank are in the improving quadrant, suggesting these sectors are gaining momentum but have not yet crossed into the leading quadrant.
  • Lagging Quadrant (Red):
    • Nifty IT, Nifty Oil & Gas, and some midcap and smallcap indices are in the lagging quadrant, showing underperformance compared to the benchmark and weakening momentum.
  • Weakening Quadrant (Orange):
    • Nifty Consumer Durables is in the weakening quadrant, implying it is still performing well but is losing momentum.

Momentum and Rotation:

  • The arrows show the direction in which the sectors are moving. The sectors in the improving quadrant, such as Nifty Energy, are moving towards the leading quadrant, suggesting that they are strengthening and could become attractive investment opportunities soon.
  • On the other hand, sectors like Nifty Consumer Durables are in the weakening quadrant and are heading towards the lagging quadrant, indicating that their relative strength is diminishing.

Sector Trends:

  • Nifty Realty is in a strong position, firmly in the leading quadrant, and its trajectory suggests continued outperformance.
  • Nifty IT is significantly lagging and shows little improvement in momentum, suggesting caution for short-term traders.

How Investors and Swing Traders Can Benefit:

  • Identifying Strong Sectors for Investment:
    • Investors can use the RRG to identify sectors in the leading quadrant, such as Nifty Realty and Nifty Metal, as these sectors are likely to continue outperforming. Allocating capital to these sectors can yield better returns.
  • Sector Rotation Strategies:
    • Swing traders can benefit by focusing on sectors in the improving quadrant, such as Nifty Energy and Nifty CPSE. These sectors are gaining momentum and might enter the leading quadrant, providing good opportunities for short- to medium-term gains.
    • Conversely, sectors in the weakening quadrant, such as Nifty Consumer Durables, can be used as a signal to reduce exposure or look for short opportunities, as they are losing strength.
  • Avoiding Underperforming Sectors:
    • Both investors and swing traders can avoid or limit exposure to sectors in the lagging quadrant (e.g., Nifty IT and Nifty Oil & Gas) as they are underperforming the benchmark and lack momentum.
  • Timing the Entry and Exit:
    • Swing traders can utilize the rotation of sectors to time their entries. For example, they could enter positions in sectors moving from improving to leading or exit positions in sectors shifting from leading to weakening.
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Thank you @insiderTrader for this valuable information. SInce I am beginner and in learning phase I have couple of questions.

  1. Where can I see these Graphs ) Any free/Paid portal that provide the insights and trends?.
  2. As shown in picture few indices are far right and big and few are very close and short. I have highlighted in picture below. How this is detrmined. Is this based on Capitla it holds or no of stocks or what. Why I am asking this is if you look at graph indices close to center point are short and very quick to swift the trend where as indices far end usually take time to move from one quadrant to other quadrant right.
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  3. Will the direction of rotation always clockwise or anti clock wise can also happen?
  4. This Graph helps mostly for Momentum/ Swing traders right. yes for long term investors in weakening/Lagging quadrants are the accumulation period. This also help in taking entry/exit positions.
  5. What are the major factors impacting these rotations like micro economics macro economics, Govt policies…etc.
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  1. Platforms
  1. Think of each index on the RRG as a car in a race. The further an index is from the center, the stronger its performance (relative to a benchmark). The big cars (indices) far away are leading the race—they’re in a strong trend and they don’t change direction quickly. The smaller cars closer to the center are in transition—they’re either losing momentum or building it up, which is why they can change direction more quickly. It’s not about the number of stocks or the market cap; it’s about their relative performance and speed.
  • In the image, the size difference and the positioning of the highlighted indices, such as Nifty CPSE and others close to the center, reflect these variations. The distance also indicates their stability; indices further from the center (like those in the leading quadrant) tend to be more stable in maintaining trends, while indices near the center may exhibit more rapid changes in trend or momentum.
  1. While most of the time you’ll see indices moving in a clockwise direction—kind of like the natural rhythm of cycles—there can be situations where the movement is counterclockwise. This often happens when there’s a sudden shift in market conditions, like a strong policy change or an unexpected economic event. It’s like a car suddenly taking a sharp turn against the usual flow.
  1. RRGs are particularly handy for momentum and swing traders since they focus on relative performance. You can see which sectors are getting stronger and make short-term moves. However, long-term investors can also use this tool. For them, if an index is in the “lagging” or “weakening” quadrant, it might mean the sector is undervalued and could be a good time to start accumulating those stocks—kind of like buying something when it’s on sale.
  1. The movement of indices on the RRG is influenced by several factors, each of which impacts the way sectors rotate through the four quadrants:

  • Macroeconomic Factors:

    • Interest Rates: If interest rates rise, sectors like banks (financials) may move towards the “Leading” quadrant as higher rates improve profitability. Meanwhile, sectors sensitive to borrowing costs, like real estate, might shift towards “Lagging.”
    • Economic Growth Data: Strong GDP growth can push consumer discretionary and industrials towards the “Improving” or “Leading” quadrant, as economic optimism generally boosts these sectors.

Government Policies:

  • Regulatory Changes: For instance, new government incentives for renewable energy could push energy-related sectors into the “Improving” or “Leading” quadrant as investors flock to benefit from favorable policies.
  • Tax Reforms: A tax cut can make sectors like FMCG (Fast-Moving Consumer Goods) more attractive, increasing their momentum, thus moving them to the “Improving” or even “Leading” quadrant.

Microeconomic Factors:

  • Earnings Results: If a specific sector’s earnings are better than expected, you might see a sharp upward movement of that sector’s position on the graph, transitioning from the “Lagging” to the “Improving” quadrant. Conversely, poor earnings can cause a fall towards “Lagging.”

Market Sentiment and External Shocks:

  • Geopolitical Events: Sudden events like geopolitical tensions might lead to a quick movement of defensive sectors like utilities or healthcare towards “Leading,” while cyclical sectors could lose momentum and fall to “Lagging.”
  • Commodity Price Changes: If oil prices fall significantly, oil-sensitive sectors like airlines may quickly move from “Weakening” to “Improving,” while the energy sector itself might drift towards “Lagging.”
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Thank you so much. This helps a lot especially for beginners like me.

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Update /October 2024

Daily

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Index whose stocks are in my wish list for this week

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Example
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Weekly

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My pick

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