Relative rotation refers to the visual comparison of the performance and momentum of different securities, sectors, or asset classes against a specific benchmark. It's a concept primarily analyzed using a tool known as the Relative Rotation Graph (RRG).
Understanding Relative Rotation through the RRG
The core idea behind relative rotation is not just how an asset is performing overall, but how it's performing relative to something else – typically a broad market index like the S&P 500 or another relevant benchmark. This comparison focuses on two key aspects:
- Relative Strength: How the asset's price performance compares to the benchmark over a period.
- Relative Momentum: How the rate of change in the asset's relative strength compares to the benchmark.
The Relative Rotation Graph (RRG)
As stated in the reference:
The relative rotation graph (RRG) is a sophisticated tool in technical analysis to help investors decide which sectors, individual stocks, and other assets to pursue. Investors can use it to visually compare the performance and momentum of securities and asset classes against a benchmark.
The RRG plots various assets on a two-dimensional chart:
- The horizontal axis often represents relative strength.
- The vertical axis often represents relative momentum.
Assets move across four quadrants on the RRG, indicating their relative rotation phases:
- Leading: Assets in this quadrant show improving relative strength and momentum.
- Weakening: Assets in this quadrant show decreasing relative momentum but still positive relative strength.
- Lagging: Assets in this quadrant show decreasing relative strength and momentum.
- Improving: Assets in this quadrant show improving relative momentum but still negative relative strength.
Analyzing the path or "tail" of an asset's movement across these quadrants over time reveals its relative rotation pattern.
Why is Relative Rotation Important for Investors?
Analyzing relative rotation helps investors:
- Identify Trends: Spot which assets or sectors are currently outperforming or underperforming the market.
- Allocate Capital: Use insights to potentially shift investments towards areas showing improving relative strength and momentum.
- Manage Risk: Identify areas that are consistently lagging or weakening relative to the benchmark.
- Gain Perspective: Understand market dynamics beyond simple price charts by seeing how different components are moving in relation to the overall market or each other.
By observing how assets rotate through the quadrants, investors can make more informed decisions about where to focus their research and potential investments, aiming to align their portfolios with areas exhibiting favorable relative performance characteristics.
