Stockpickr) -- There's an old saying on Wall Street that "it's a market of stocks, not a stock market." In large part, that's true -- single stocks often trade in directions that are divergent from the broad market; identifying them is the domain of the successful trader.
But even with that in mind, it's a huge mistake to underplay the importance of the stock market as a whole.
That's because, clever sayings aside, the vast majority of stock movements are highly correlated with one another and with the collective market itself. That's become more evident than ever in the last few decades, as index funds became the most popular investment choice for Americans' retirement portfolios. With exposure to a diversified basket of stocks that's designed to track "the market," these funds are directly impacted by losses in the indexers they track.
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On a practical level, it makes a lot of sense that most stocks trade in tandem. It has more to do with the flow of funds into and out of the market than with the specifics of any particular stock -- as investors tried to liquidate stock positions and free up cash in the recession of 2008, for instance, they were selling the good alongside the bad in order to stay solvent. In the process, even fundamentally sound stocks got pushed significantly lower as the broad market crashed.
But investors don't need to be beholden to the market. By measuring market strength, you can target asset classes that look to be the strongest performers when times are tough, and you can spot early signs of broad market reversals when times are good. Today, we'll explore some popular measures of market strength.
Relative or Absolute Market Strength
Market strength is a broad term that can mean a lot of things, depending on how we define it. Market strength can be a measure of a market's power to perform either on a relative basis (vs. other markets) or on an absolute basis (vs. its own historical levels of momentum and investor participation).
First, we'll take a look at the
of a market. Relative strength is a
metric that's not relegated to intermarket analysis (that is to say, it can be used for individual stocks just as effectively), but it's arguably at its most powerful when used to help select the strongest asset class.