
Relative Rotation Graphs, commonly referred to as RRGs, are a unique visualization tool for relative strength analysis. Chartists can use RRGs to analyze the relative strength trends of several securities against a common benchmark, and against each other. 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 visualize 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 securities move from one quadrant to the other over time.
Note: “Relative Rotation Graphs^{®}” and “RRG^{®}” are registered trademarks of RRG Research.
RRGs were developed in 20042005 by Julius de Kempenaer, who would later become the Director of RRG Research. While working as a sidesell analyst for an investment bank in Amsterdam, he was confronted with two problems while producing technical and quantitative research on European sectors. First, institutional clients were much more interested in relative performance than directional forecasts; they wanted to know where to be overweight and where to be underweight in their equity portfolios. Second, these institutional investors faced an enormous information overload; they needed a tool that would clearly separate the leaders from the laggards. Enter Relative Rotation Graphs, which solved these problems with colorcoded quadrants, a ranking table and an animation feature that make it easy for investors to keep an eye on the big picture.
Before looking at the construction of Relative Rotation Graphs, let's look at the two main inputs: JdK RSRatio and JdK RSMomentum. Note that both input indicators are “normalized,” which means these indicators are expressed in the same unit of measure and fluctuate above/below the same level (100). This normalization process means RSRatio values for different securities can be compared, as long as the same benchmark is used.
RSRatio is an indicator that measures the trend for relative performance. Similar to the price relative, RSRatio uses ratio analysis to compare one security against another (usually the benchmark). It is designed to define the trend in relative performance and measure the strength of that trend.
The chart below shows the Technology SPDR (XLK) in the main window, the price relative (XLK:$SPX ratio) in the middle window and the RRG indicators in the bottom window. We will focus on RSRatio (red) first. RSMomentum (green) will be covered in the next section.
RSRatio gives chartists a clear tool to define the trend in relative performance. This indicator reflects an uptrend in relative performance when above 100 (relative strength) and a downtrend in relative performance when below 100 (relative weakness). The further the indicator is above 100, the stronger the uptrend in relative performance. The further the indicator is below 100, the stronger the downtrend in relative performance.
As with all trendfollowing indicators, such as moving averages, the trendfollowing model that powers RSRatio includes a lag period. This means there will already be upward movement in the price relative before RSRatio crosses above 100. Conversely, there will already be downward movement in the price relative before RSRatio crosses below 100. Notice on the chart above how the price relative (XLK:$SPX ratio) peaked in early August, but RSRatio did not cross below 100 until midOctober. Similarly, the price relative bottomed in midJuly, but RSRatio did not cross above 100 until midSeptember. This is typical for trendfollowing indicators that are designed to ignore the blips and focus on the trend. The chart below shows the Consumer Discretionary SPDR (XLY) with another example.
Keep in mind that the values for RSRatio can be compared when using the same benchmark security. Let's assume we are comparing relative performance for four sector SPDRs against the S&P 500 and the RSRatio values are as follows: XLK=102.04, XLI=101.41, XLF=100.2, and XLV=103.66. First, all four have RSRatios above 100 and this means all four show relative strength (against the S&P 500). Second, XLV shows the most relative strength because its RSRatio is the highest of the four. XLF is the weakest of the four because its RSRatio is the lowest.
Before looking at RSMomentum in detail, let's review the concept behind momentum and how it relates to trend. As with price charts, chartists should keep in mind that momentum changes course before the trend actually reverses. Not all momentum moves, however, result in trend reversals.
Consider an example using price and a moving average. Price first moves towards the moving average and then crosses it if the move extends. Price, however, does not always cross the moving average to signal a trend reversal. Aggressive traders would more likely take a position as price moves towards the moving average because this means momentum is improving. Conservative investors would more likely wait for price to move above the moving average because the trend has not fully reversed.
RSMomentum is an indicator that measures the momentum (rateofchange) of RSRatio. As a momentum indicator, it leads RSRatio and can be used to anticipate turns in RSRatio. Typically, RSMomentum crosses above 100 when RSRatio is forming a trough and starting to move up. Conversely, RSMomentum crosses below 100 when RSRatio is forming a peak and starting to move down.
The chart below shows the Utilities SPDR (XLU) with RSMomentum in green and RSRatio in red. RSMomentum crossed above 100 in midDecember and held mostly above 100 for four weeks. Notice how RSRatio bottomed as RSMomentum moved above 100 and RSRatio crossed above 100 later in January.
Keep in mind that RSMomentum is an indicator of an indicator (RSRatio). Furthermore, as a momentum indicator, it will move above/below the 100 level often. Chartists may want to focus on sustained moves above/below 100 to anticipate a similar cross in RSRatio.
The chart below shows the Biotech SPDR (XBI) with two examples highlighting the relationship between RSMomentum and RSRatio. The gray shading shows RSMomentum below 100 for four of six weeks in FebruaryMarch. Even though the indicator popped above 100 briefly, this pop did not last long and quickly moved back below 100. This was a sign that momentum was turning negative for RSRatio and RSRatio ultimately crossed below 100 in the second half of March.
The blue shading shows RSMomentum above 100 from midApril until late May. RSRatio bottomed as RSMomentum moved above 100, but did not cross above 100 until the end of May. Additionally, note that the cross above 100 in RSRatio came just before the early June surge in XBI.
Relative Rotation Graphs are plotted on a standard scatterplot canvas with an xaxis (horizontal) and a yaxis (vertical). The JdK RSRatio indicator is the input for the horizontal axis, and the JdK RSMomentum indicator is the input on the vertical axis. These axes cross at 100 to create four relative performance quadrants. The Relative Rotation Graph simply plots RSRatio and RSMomentum values for each symbol. If the symbol universe is the nine sector SPDRs and the S&P 500 is the benchmark, we will see nine points on the Relative Rotation Graph (RRG) and each point represents that particular sector's RSRatio and RSMomentum value.
The Relative Rotation Graph is shown above with four possible combinations. Let's assume we are using the nine sector SPDRs as our universe and the S&P 500 as the benchmark.
The arrows on the model Relative Rotation Graph above show the idealized rotation, which is clockwise. Let's assume a sector is currently in the leading quadrant (green) and follow the idealized rotation. Remember, RSMomentum 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 RSMomentum will move below 100, which will cause the sector to move into the lower righthand quadrant (weakening). Extended weakness in relative momentum will ultimately affect the trend in relative performance and RSRatio will also move below 100, which would put the sector into the lagging quadrant (red). Once in the lagging quadrant, the first sign of strength will be an improvement in relative momentum. When RSMomentum crosses above 100, the sector will move into the improving quadrant (blue). A sector in this quadrant still has a downtrend in relative performance, but RSMomentum 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 RSRatio will move above 100. This will push the sector into the leading quadrant (green) and the cycle will start over again.
Rotation comes alive with the historical trails. The chart below shows the nine sectors with 12week trails; we can see each sector rotating from one quadrant to another. Each point marks one week, and the solid point with the symbol marks the most recent point. At the top, XLF moved from improving to leading. At the bottom, XLU moved from weakening to lagging. The blue line shows XLP moving from weakening to lagging, and then from lagging to improving. The improving quadrant means RSMomentum moved above 100, but RSRatio remains below 100. XLY moved into the leading quadrant when both RSRatio and RSMomentum were above 100.
Chartists can also glean information from the length of the trails and the thickness of the trail lines. All trail lines extend 12 weeks on this chart, but some are longer than others. The red XLU trail is the longest, meaning it has the biggest move and shows the most volatility. The green XLY line in the upper right is the shortest, which means it has the smallest move and is the least volatile.
The thickness of the lines depends on the distance from the benchmark, which is the crosshair on the RRG. The crosshair is also known as the origin where the xaxis (RSRatio) crosses the yaxis (RSMomentum). Thicker lines will be further from the benchmark, and thinner lines will be closer to the benchmark. The further a security is from the benchmark, the bigger the move in relative performance (up or down). The closer a security is to the benchmark, the smaller the move in relative performance (up or down). In other words, the thicker lines represent bigger moves and the thinner lines represent smaller moves.
Users can change the trail length using the slider next to the Relative Rotation Graph. Chartists are encouraged to experiment with the trail length and the number of symbols on the graph. In general, chartists should shorten the trail length when there are a lot of symbols on the graph. This will help declutter and make the analysis easier. Longer trails are fine when just a few symbols are shown on the graph.
Before looking at some interpretation guidelines, bear in mind that Relative Rotation Graphs 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 rulesofthumb you may want to follow:
As with normal bar charts, line movements on a weekly RRG can look a lot different than line movements on a daily RRG. For example, the weekly RRG below shows the S&P Telecommunications Sector ($SPTS) in the lagging quadrant and clearly red. In contrast, the daily RRG shows the sector rotating from the lagging quadrant all the way to the leading quadrant. How can this be?
The chosen timeframe affects RRGs just like regular bar charts. In the example below, the left chart shows two months of daily data for the S&P 500, and the twomonth trend is down. The chart on the right shows one year of weekly data and the overall trend is clearly up. The yellow shaded area highlights the two months shown on the daily chart to put this decline into perspective. Clearly, this is a shortterm downtrend (pullback) within a longterm uptrend.
The chosen timeframe affects RRGs the same way. A sector moving into the weakening quadrant on the weekly timeframe, like the Telecom sector above, can be in the leading quadrant on the daily timeframe as the sector is going through a shortterm positive rotation. This shortterm rotation, however, is not powerful enough, yet, to influence the rotation on the weekly RRG.
This can be clarified a bit more by looking at RSRatio and RSMomentum on bar charts. The first chart shows weekly RSRatio and RSMomentum, which correspond to the weekly RRG plot. The second chart shows daily RSRatio and Momentum, which correspond to the daily RRG plot. Notice how the weekly indicators show negative momentum and a longterm downtrend in relative performance. The daily indicators, on the other hand, turned up and moved above 100.
Assuming that weekly rotations are stronger than daily and that a rotation will follow its normal clockwise course, one would expect the positive rotation on the daily timeframe to be temporary in nature. In a normal rotation, the sector would move through the leading quadrant, cross into the weakening quadrant and push into the lagging quadrant, thus keeping it solidly inside the lagging quadrant on the weekly timeframe! In other words, the daily move is a shortterm “hiccup” within an otherwise falling relative trend on the weekly.
As with all aspects of technical analysis, it is a very good habit to study different timeframes to get a complete picture. The Telecom sector is clearly deep inside the lagging quadrant on the weekly RRG  and moving further into the red. The decrease in negative momentum, which can be seen by the leveling of the trail slope on the weekly RRG, translates into a quick positive rotation on the daily RRG.
Relative Rotation Graphs make it easy to separate the market leaders from the market laggards. In this regard, RRGs save time, and money, because they narrow the focus to parts of the market that deserve attention for further analysis. RRGs can be tailored to suit any trading or investing style because they measure both momentum and trend for relative performance. Momentum traders can focus on crosses into the improving quadrant or the weakening quadrant. Trend followers can focus on crosses into the leading quadrant or lagging quadrant. Keep in mind that these are relative performance indicators, and there is still a risk that the rotation turns back or even reverses. As with all technical tools, these relative performance indicators should be used in conjunction with other technical tools to give chartists a more complete picture.
Chartists can access RRG Charts by clicking on “Charts & Tools” at the top of any web page at StockCharts. Simply click the “Launch RRG Chart” button in the Relative Rotation Graphs section of the Charts & Tools page. Our RRG Charts article in the Support Center describes how to use all the controls.